Analysts have been racing to revise earnings estimates upward of late, but those projections could easily still be too low. That could mean more upside for stocks even though the market has been hot recently.
Earnings estimates for 2021 for the average S&P 500 company have been revised higher by 8% in the past six months, according to FactSet data.Covid-19 vaccines have found arms at a fast pace, enabling states to reopen, which has been met by pent-up demand resulting fromtrillions of dollars of fiscal stimulus. Given that, revisions upward may now be less frequent.
But there is indeed more upside to earnings, according to analysis from Credit Suisse strategists. For every percentage point of additional gross domestic product growth, revenue growth on the S&P 500 is roughly double, historically, Credit Suisse said. With GDP expected to grow just over 7% in 2021—the fastest clip in decades as the economy normalizes after the lockdowns of 2020—S&P 500 revenues could grow about 14%.
But analysts only expect aggregate sales growth on the index of around 9% for the year, according to FactSet data. Considering current revenue estimates, Credit Suisse’s analysis implies roughly 4% upside to sales projections.
Earnings would have even more potential to rise. For many S&P 500 companies—think of manufacturers, retail businesses, and food-chain operators—increased sales often mean even higher profit growth. That is because those companies have high operating leverage: A significant portion of their costs don’t vary much, so when sales rise, profit margins expand and earnings grow robustly.
Credit Suisse is forecasting EPS growth of 34% in 2021, higher than the consensus estimate of 25%.
Would higher expectations pump stock prices upward significantly? One challenge is that stocks already reflect a high degree of optimism. The S&P 500 is up almost 20% since late September,when investors resumed buying up assets most sensitive to changes in the economy.
That has brought valuations to fairly high levels, with the average stock on the index trading at just under 22 times the per-share earnings expected for next year, compared with the long-term average of 15 times.
But interest rates have recently been on the rise,which makes stocks less attractive.Many on Wall Street see the S&P 500 trading down to 20 times the earnings expected for next year.While expectations of bigger profits could help stocks, the gain would be partially offset if shares trade at a lower multiple of forecasted earnings.
The most economically sensitive stocks are some of the best ones to play the earnings story.Cyclicals have run hot,but some still look good.
Norfolk Southern (ticker: NSC) could achieve earnings per share of $16 by 2023,Citigroup analysts wrote in a note. That would put the rail and transportation company on a path to grow earnings at a 20% clip for the next three years, up from the 13% FactSet data indicates Wall Street analysts currently expect. While the stock is trading above its average price/earnings ratio for the past five years, the Citi analysts still see room for a 37% gain in the shares.