We’ll be having Forward’s Q1 Webinar at 1:00 EST on 4/20. Registration link here.
Amid a tenuous economic background characterized by global conflict, tighter financial conditions and persistent inflationary pressures, publicly traded companies will provide their first look into 2022 as they report Q1 results over the coming weeks.
While expectations for the current quarter have fallen since January 1st, full-year growth estimates for Calendar Year (CY) 2022 and CY 2023 remain in line with long-term averages (Chart via Factset). The message? Expectations for corporate performance remain strong despite a host of challenges.
While investors evaluate economic growth net of inflation’s impact, corporate activity is viewed from nominal revenues (sales) and profits. Revenues, the topline of the income statement, should be robust as inflationary pressures provide companies with pricing power. Revenues become profits via the net profit margin—referred to as “margins.” How much escalating labor and input costs impact margins remains a key question to be evaluated during earnings season and will largely influence how stocks perform in the near-term. It is noteworthy to mention that the estimated net profit margin for the S&P 500 for Q1 2022 is 12.1%, above the 5-year average of 11.2%. Thus, margins are elevated and at risk of disappointing this earnings season and for several quarters to come.
In addition to margins, a secondary risk factor to stock price performance near-term will be further contraction in P/E multiples. P/E multiples can be calculated in a variety of ways. Every calculation uses the same “P”, or Price (in this case Price is the Price of the S&P 500). The difference in calculation methods is due to differences in the “E”, or Earnings. Given we are looking at forward earnings estimates for CY 2022 and CY 2023 in today’s note, we will let “E” be represented by the next 12-months of S&P 500 earnings. This forward-looking P/E measure peaked in late 2020 and has been working its way lower to present day (Chart via Factset):
What does this tell us? One way to view P/E multiples is as a gauge of investor sentiment, answering the question—“How willing are today’s investors to pay for tomorrow’s earnings?” Investor enthusiasm swung wildly starting in 2020, ending at euphoric levels in the final days of Covid. Since then, uncertainty has been rising, inflation is now “sticky” and in a cyclical upswing, and the flow of liquidity as measured by *expected* low interest rates and quantitative easing is now persistently reversing. All three of these factors likely point toward further contraction in the forward P/E multiple, as investors may want more assurance that tomorrow’s earnings will indeed be worth paying for.
Forward’s 2022 Q1 Webinar- registration link here
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