The age of double-digit profit growth for American companies appears to be over.
Investors made some pretty hefty portfolio gains in 2006 amid the stock market’s record run, a rally fed in large part by nearly five years of unprecedented earnings growth. But it’s universally accepted on Wall Street that U.S. corporations won’t be able to deliver in the new year the kind of results shareholders have become accustomed to.
“It had to end at some point,” said Jack A. Ablin, chief investment officer at Harris Private Bank. “There is distrust associated with the high level of profits, especially when you see 10 percent profit margins. That’s just unsustainable.”
For the most part, growth in the Standard & Poor’s 500 as an index closely mirrors that of corporate earnings. The index finished last year up 15.8 percent, while all the S&P 500 members posted an average 16.2 percent profit gain.
For 2007, stock market analysts like Ablin feel the S&P 500 index will grow by about 9 percent. Profit for members of the index are expected to make a similar advance.
The most direct evidence of this will likely be seen when companies begin reporting fourth-quarter results next week. Alcoa Inc. marks the official start of earnings season when it posts results on Tuesday.
Operating earnings during the fourth quarter are expected to show the lowest year-over-year gain in more than four years, according to a report from Standard & Poor’s. The rating agency estimates its flagship 500-stock index will post earnings of $22.08 per share, or $199 billion in aggregate — a 9.4 percent gain over the year-ago period.
This marks the first single-digit earnings gain for the index since the first quarter of 2002. However, S&P still projects 2006 will go down as the best year ever for corporate profit with a 14.9 percent gain over 2005.
Alec Young, S&P’s international equity strategists, said that although this year won’t shape up to be anything like 2006, “it’s still pretty attractive looking at the stock markets as a whole.” He said gross domestic product growth is slowing, and that will put pressure on profits in 2007.
“Complaining about this year would be like complaining you have a brand new BMW instead of a Porsche,” he said. “Its just that 2006 was so great, this year is just a subject of tough comparisons.”
An example of the huge profit levels can be seen in Exxon Mobil Corp. The oil company scored the biggest profit of all time for a public company after posting $10.71 profit in the 2005 fourth quarter. And, then scored the second-biggest profit during this past third quarter with earnings of $10.49 billion.
Results are still expected to be historically strong for Exxon and other companies, but still lower than seen in 2006.
One of the reasons behind the slowdown has been a drop in value over the fiscal year for consumer discretionary stocks. Companies selling everything from big screen televisions to high-end clothing fared well because of the housing market boom.
However, stock values began to erode as the bubble burst. These companies are not expected to lock in the same kind of profit during this past fourth quarter as they did a year earlier. Sectors like technology and telecommunications — both at their heights during the year-ago period — are also seen lower.
Although corporate profits are expected to be close to halved overall, analysts frame the shift as a good thing for the stock market. It’s seen as injecting confidence into investors worried about when the ball might drop, and adds stability to stocks that some felt were overvalued.
It also may set up fast-growing sectors like technology and health care to have a good year. Both were shunned in 2006 as investors dodged riskier industries.
“The reason why growth sectors like technology and health care took a back seat last year is because earnings growth was really easy to come by,” Ablin said. “Should earnings growth slow considerably in 2007, (and) investors get worried that the end of the profit parade is over, then we might see a shift toward growth-oriented sectors.”