Are accounting magic tricks driving the stock market earnings growth?

Are accounting magic tricks driving the stock market earnings growth?

I was forwarded a newsletter from Lance Roberts that had some very interesting charts and comments. I was particularly struck by his analysis of how the engine of this latest leg of the bull market is partially divorced from reality.

The following chart caught my eye immediately:

This chart shows how stock buybacks are boosting the all-important metric of Earnings Per Share by lowering the number outstanding shares (the denominator of the EPS equation).

...there has been a stunning surge in corporate profitability despite a lack of revenue growth. Since 2009, the reported earnings per share of corporations has increased by a total of 336%. This is the sharpest post-recession rise in reported EPS in history. However, that sharp increase in earnings did not come from revenue which has only increased by a marginal 49% during the same period.”
— Lance Roberts

Normally you would assume that if profits are going up that they are driven in large marge by increasing sales. But that does not seem to be the case here. He points out that while reported EPS has grown 336% since 2011, Sales Per Share has only increased 49% over the same period.

So corporations are buying back there own shares to reduce the number of shares outstanding, which increases the EPS, which in turn drives the stock price up. Good work if you can get it. And where is all the money to buy back all these shares coming from? From the Ryan-Trump tax bill, of course:

Furthermore, while the majority of buybacks have been done with ‘repatriated’ cash, it just goes to show how much cash has been used to boost earnings rather than expanding production, making productive acquisitions or returning cash to shareholders.
— Lance Roberts

The net result of this accounting magic is that corporate profit growth has diverged from the growth of the overall economy, as shown in the chart below.

What this chart shows is that in the past corporate profits would grow in lockstep with the overall economy, e.g. in the mid-to-late 60s. But currently the chart shows corporate profits growing substantially faster than the overall economy.

Mr Roberts poses the following question:

How long can corporate profit growth remain detached from slower rates of economic growth?

Great question, and fundamental to anyone who has money invested in this stock market. His response to his own un-answerable question is in the form of a Caveat Emptor statement: 

I don’t have a clue and neither does anyone else. But disregarding reality in a quest to chase market-based returns has always ended badly when the “herd” inevitability turns.
— Lance Roberts

Play Safe.

Happy Birthday, America

Happy Birthday, America

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