Strong Start to the Year for Earnings

The first quarter earnings season has been better than expected. With 464 of the 500 companies in the S&P 500 already reporting, earnings per share (EPS) for the index constituents are up 5.4% year-over-year (FactSet). That’s the best rate of growth since the first quarter of 2022, and it’s well above analysts’ expectations going into the quarter of 3.4%. Revenue for the group of 464 is up a slightly more moderate 4.1% – roughly in line with the fourth quarter 2023 growth rate but still relatively solid. We show the EPS and revenue growth rates for the past nine quarters in the chart below. 

The solid 1Q earnings reports are leading analysts to further increase their earnings estimates for this year and next. At present, the consensus expectation is for S&P 500 EPS to grow 11% this year to $242.73. You can see in the chart below that that estimate has been increasing each month since bottoming out in January. The outperformance in the first quarter has contributed to those upside revisions. For 2025, EPS are currently expected to grow another 14% to $276.75. That lofty growth rate likely reflects the widespread expectation for an economic soft landing whereby inflation continues to moderate, economic growth remains solidly positive and the Fed is able to start the process of bringing short-term interest rates down to more normalized levels. 

The S&P 500’s price rebound back to record territory likely reflects those same optimistic expectations. It’s important to note, though, that valuation levels (as measured by the P/E multiple) are being held somewhat in check by rising earnings expectations. The chart below shows that the current P/E multiple for the S&P 500 is around 20.6x forward earnings. If the index stays at the same level as today for the rest of the year and earnings estimates for 2025 remain unchanged as well, the P/E multiple would drop to just 18.9x – not terribly far above the 10-year average of around 18x. The decrease in P/E multiple would reflect the increase in the denominator, which at that point would be the consensus estimate for 2025 ($276.75). Of course, there’s always the chance that EPS estimates could continue to drift higher by year end, which would result in an even lower P/E multiple at year end. And then there’s the chance that the estimates for 2025 are too high.

It probably goes without saying that the current level of investor optimism regarding the economy and corporate earnings borders on complacency. Yet so far investors have been right to be optimistic. Stocks have climbed a wall of worry and currently stand at record highs even though interest rates are sharply higher. In my view, corporate America will have to deliver earnings growth at least as robust as current expectations in order to build on their year-to-date stock gains. Is that impossible? Certainly not. But there’s clearly not much room for error.