Key takeaways

  • Fourth quarter 2023 S&P 500 earnings generated growth on a year-over-year basis for the second quarter in a row.

  • With more than two-thirds of companies reporting results, earnings growth is 2.9% higher than a year earlier.

  • The direction of 2024 earnings will likely be driven primarily by the strength of the global economy.

Corporate earnings, considered a key gauge of the health of publicly traded companies, moved in an encouraging direction in the second half of 2023. The improvement came after earnings declined (in comparison to the same quarter in the prior year) in 2023’s first and second quarters. Earnings recovered, generating positive year-over-year gains in the third quarter, and appear to be on pace to do the same when fourth quarter results are finalized.1

“Earnings growth is much improved, on the strength of solid results for technology companies,” says Rob Haworth, senior investment strategy director at U.S. Bank. “Generally speaking, the market has to be encouraged by the fourth quarter 2023 results that have been reported in recent weeks.”

While investors continue to closely monitor factors like economic data and Federal Reserve (Fed) monetary policy, Haworth notes that over the long term, no factor may have more impact on the performance of individual stocks than company earnings. Earnings represent a corporation’s net profits and provide a gauge of the financial health of a company and a stock’s potential performance in the future. Earnings expectations often help drive the direction of the broader stock market.


Maintaining strong financial performance amid economic headwinds

The U.S. economy expanded at an annualized rate of about 2.5% as measured by Gross Domestic Product (GDP) in 2023.2 That number exceeded most economists’ expectations considering tighter Fed monetary policy. In response to soaring inflation in 2021 and 2022, the Fed increased short-term interest rates by more than 5% in 16 months spread across 11 separate rate hikes intended to lower inflation by tempering consumer demand.

Higher interest rates and slower economic growth slowed the pace of corporate earnings. By mid-2022, earnings growth softened, a trend that continued until the third quarter of 2023.

Chart depicts actual and projected quarterly earning for S&P 500 companies Q1 2022 thru Q4 2024.
Source: FactSet, “Earnings Insight,” February 9, 2024.

Based on analysts’ estimates as of February 2024, “S&P 500 earnings are projected to come in at $240/share in 2024 – about a 10% improvement from 2023,” says Haworth. Yet he notes that some challenges remain given the economy's modest growth rate, persistent inflation and elevated interest rates. “The general expectation is that the rate of economic growth will moderate in 2024 from 2023’s 2.5% level,” says Haworth. “If the economy slows, current expectations for 2024’s earnings growth may be overly optimistic.”

However, Haworth also notes that if a recession is avoided, investors may conclude earnings expectations were too pessimistic, and favorable earnings surprises could result. Often when that occurs, the stock market reacts positively.


Role of earnings in stock valuation

The publicly traded companies represented as stock holdings in your portfolio deliver quarterly financial statements that include a wide range of information. This includes a breakdown of sales (revenue) and expenses, the two key factors that determine earnings.

Earnings information is important because it provides a glimpse into the company’s business success in recent months. In many cases, companies provide “guidance” regarding their future earnings and growth prospects. This guidance serves as a preview of what may come based on trends companies experience in their businesses. While corporations often provide earnings guidance, it’s not a requirement. According to FactSet, as of February 9, 52 S&P 500 companies provided “negative” first quarter 2024 earnings guidance, a signal to investors that a company’s quarterly earnings for the quarter may be less than initially expected. By contrast, 21 companies provided “positive” guidance, indicating they anticipate better-than-expected quarterly earnings results.1

“S&P 500 earnings are projected to come in at $240/share in 2024 – about a 10% improvement from 2023,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management.

Professional stock analysts often estimate, in advance, their own expectations for what companies will report each quarter. “Investors are very attuned to the forward-view of earnings, which reflects the stock market as a discounting mechanism,” says Haworth. In other words, stock prices are based less on a company’s past performance and more on expectations of future financial success. “Stock prices typically incorporate a consensus market belief about the future state of a company, including earnings, growth prospects, risks, pricing challenges and other factors,” says Haworth.


Factors in valuing a company’s stock

Earnings provide the basis of one of the major measures of a stock’s individual value. Investors often use a statistic known as the Price-to-Earnings (P/E) ratio to help assess how expensive a stock is relative to the rest of the market. In other words, it is the ratio of the current price of a stock compared to the company’s earnings. If a stock is trading at $30 per share and the company’s annual earnings are $2/share, the P/E ratio is 15.

Haworth notes that P/E ratio is just one measure of a stock’s performance. “We look at a variety of valuation assessments, including sales growth and book value growth, which is essentially a way of estimating the liquidation value of a company.” Other factors would include a company’s cash flow and a stock’s dividend yield.

When trying to assess which of two stocks offer the best investment opportunity based on their P/E ratios, it’s not always an “apples-to-apples” comparison. “Determining fair value has a lot to do with the underlying growth rate of the industry in which the company competes,” says Haworth. In some cases, investors may be willing to bid up prices based not on current earnings, but on expectations of future profitability. “This tends to be the case, for example, with stocks that invest in new technology that may not have an immediate payoff but offer the potential of future strong earnings if they succeed,” says Haworth. “Other stocks may have lower P/E multiples, but those companies generate steadier earnings, so the payoff on the investment needs to happen in a more compressed timeframe.”

Other variables can be reflected in the earnings they report. “It’s worth reading beyond the headline numbers,” says Haworth. “Unique, one-time events may affect earnings, either positively or negatively.” For example, if a company’s earnings declined due to a one-time major expense, that shouldn’t necessarily reflect poorly on its outlook. Similarly, if a company reports a strong boost to earnings, for example, because it sold off one of its business units, that may not reliably indicate future strength.


How earnings are reflected in the broader stock market

As they do with individual stocks, analysts can place a P/E valuation on the broader market. As of January 31, 2024, the P/E ratio of the S&P 500 based on earnings in the prior 12 months was 23.27, while the P/E ratio based on projected earnings for the next 12 months is 20.23.3 Analysts may set different valuations on the market based on varied sets of projections.

With S&P 500 P/E ratios based on projected earnings exceeding 20 times earnings, Haworth says the market may, on the face of it, look expensive, “but we’re in a different state now. Interest rates are elevated, inflation has come down significantly, so higher market multiples (P/E valuations) may be justified.” Haworth notes that technology-related stocks make up more than one-third of the S&P 500’s valuation in today’s market. “These companies are generally expected to realize faster, long-term growth rates, so they are often valued at higher multiples than other types of stocks.” Haworth believes that’s a factor influencing the current high valuations of the broader S&P 500 Index.


Preparing for the current environment

Haworth believes that earnings, while always an important consideration driving investor sentiment, may be overshadowed in the near term. “To this point, earnings for the broader market have mostly met investor expectations, so in the short term, the market has been more susceptible to fluctuation based on the Fed’s interest rate policy and economic data affecting the Fed’s position,” says Haworth. “Now we’re waiting to see what impact the direction of the economy will have on business and consumer spending and how that affects corporate profit margins going forward.” While positive stock market performance was mostly limited to technology, communication services and consumer discretionary stocks in 2023, Haworth says that investors continue to await “broader participation in the market, both in terms of stock price performance and earnings results from individual companies that did not experience favorable stock price results in 2023.”

As you assess your investment options and how to best position your portfolio, it can be helpful to do so in the context of a financial plan. Talk with your U.S. Bank wealth professional to review whether changes to your investment strategy may be warranted to better reflect your goals, risk appetite and time horizon.

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  1. FactSet Research Systems, Inc., “Earnings Insight,” February 9, 2024.

  2. Source: U.S. Bureau of Economic Analysis.

  3. Source: S&P Dow Jones Indices, S&P 500 Fact Sheet (USD), October 31, 2023.

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