Earnings slump coming to an end

The stock markets have seen fierce rallying.

The S&P 500 index is up more than 9% since the end of October. Nasdaq Helsinki is up almost 9% in the last three weeks. Time will tell whether we are finally in the early stages of a new boom, or whether this will turn out to be another bear market rally. Personally, I would be inclined to be optimistic when the bull market has been on for a year in the rest of the world, but I am often wrong. For young net equity buyers in particular, timing the bottom is not important, but building a portfolio of quality businesses at low prices is a cause for celebration. The longer the horizontal development goes on, the better for long-term wealth accumulation.

In this post, let's talk about the earnings season. In both Finland and the US, the Q3 earnings season is practically over. I will try to highlight some companies like Nordea as an example to offer more concreteness.  Let's also look at some whole sectors so Nasdaq Helsinki investors get a good context for companies like Nordea and Fortum. After reading this post, an investor will have a cursory understanding of how the earnings season went and what is expected from listed companies in terms of results in the coming years.

Earnings season: Earnings slump coming to an end

After last week's big earnings announcements such as Sampo and Outokumpu, the earnings season is practically over in Finland. According to Bloomberg, Nasdaq Helsinki’s overall EPS fell by 20% year-on-year, although the stock market is quite heterogeneous in composition and there are huge differences between companies and sectors. The decline is explained in particular by the slump in earnings of large companies such as Fortum. For example, Nokia's earnings per share halved. The forest sector is struggling in a historically difficult sector downturn and UPM's profit fell by 75%.

In contrast, the banking sector that is enjoying the high interest rates saw profit improvements of more than 100%, for banks such as Aktia and Oma Säästöpankki. The most popular stock among Finnish investors Nordea’s result grew by 40%. 

The present value of companies is their cash flows over the next few decades. Thus, a summary performance report of a single quarter is ultimately a checkpoint of limited relevance. It is not so much the results that matter, but how they meet expectations and especially what can be expected from the business in the future. For example, Nordea's share price did not rise on a triumphant 40% improvement in earnings because investors, who were terrified of their own mortgage rates, anticipated a massive improvement in earnings. Instead, the stock is flatlining and looking cheap, as investors worry about future interest rate declines, thinning interest margins and credit losses from a potential economic downturn.

Bloomberg had an interesting observation about how in Europe in general banks will see expenses grow faster than revenues in most cases next year. Nordea's costs are also forecast to grow faster than revenues. Globally, investors look at stocks across whole sectors and clearly the European banking sector isn’t the most popular club on the block.

The stock market doesn't look in the rear-view mirror, but intently at the windscreen and the next bend.

A month ago, I reviewed the valuation of Finnish equities in a post entitled Helsinki Stock Exchange is cheap. With updated forecasts in the wake of the earnings season, the message hasn’t changed. A month ago, Inderes analysts expected the more than 150 listed companies under our coverage to post net income of EUR 19.4 billion this year. One company has been added during the month, but in practice the earnings expectations as a group have risen quite sharply as the stock market as a whole is now expected to generate EUR 19.8 billion this year. Next year's result would be EUR 20 billion, almost the same as before.

The market capitalization of all monitored companies is still around EUR 250 billion and the stock market valuation is on the cheap side with a P/E ratio of less than 13 at projected 2023 earnings. For many companies, the Q4 is the biggest quarter of the year, but with the year almost wrapped up, I think that forecast will roughly hit the mark. The dividend yield of the stock exchange is 5.3%.

Naturally, the stock market is weighed down by the eternal worries of recession, the slowdown in the Chinese economy, the problems in Europe, the stagnation of the Finnish economy, etc. However, in return, the investor can become a shareholder even in good Finnish companies at a bargain price until the dog finally has its day. This has become a recurring phrase in my posts.

If Bloomberg’s consensus projections are to be trusted, the results bottomed out during the Q3 earnings season. And after next year's standstill, results should rise close to the 2022 record level in 2025. Time will tell.

If we take a quick look at earnings growth across Europe to provide important context for the performance of Finnish listed companies, the story is similar. This year, results will fall slightly and then recover for a couple of years at an annual rate of 7%.

Several sectors, such as the energy and finance sectors, are mainly shining with dividends while the outlook for profit growth is mutedly negative. The dividend yield for the entire European stock index is just under 4%, but the banking index where Nordea lives offers a dividend yield of 7.5%. The Utilities Index, inhabited by Fortum and its friends, provides a 5.5% yield. The index with Neste and other oil scoundrels offers a 5% dividend yield. When growth prospects are subdued and return on capital is poor, it’s worth returning the money to the owners.

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Similarly, across the border in the US, more than 80% of companies exceeded expectations. The earnings slump is over. Results flew 8% above the low bar set by the analyst consensus. For the whole group, profit growth was just under 3%. The earnings bottom has been touched and from now on, the results should start to grow, as I have pointed out in previous posts.

Suffice it to say that results are expected to hit a record already in the fourth quarter. In principle, juicy earnings growth should support the stock rally that started more than a year ago. This graph shows the growth of the S&P500 index, the S&P500 without the Magnificent Seven, i.e., mega-techs like Apple and Microsoft, and the small company index Russell 2000 by quarter relative to the previous year. This highlights how small companies in particular have been hit by a difficult economy and inflation, with earnings falling by up to 40%.



If you want to pick something negative out of the results, the decline in earnings has come at a time when nominal economic growth in the US has been a really brisk 6-8% over the last year. Of course, a significant slice of the S&P500 index's performance comes from the rest of the world, but in practice the economy has performed better in areas such as services, where the profit contribution of listed companies is more limited. In addition, companies’ profitability suffered momentarily from inflation.

However, the S&P500 index is now back on track, mainly thanks to mega-techs. The other 493 more mediocre companies won’t catch up until the first quarter of next year.

When looking at the US stock market, it’s increasingly important to look at mega-techs separately from others, as they dominate indices. This graph shows the Magnificent Seven mega-techs in their own index, the S&P500, the world stock exchange index and the sympathetic Nasdaq Helsinki. The index comprised of mega-techs has increased fivefold, the S&P500 has returned just under 60% and Nasdaq Helsinki has dropped one per cent during this period.



The heavy returns of mega-tech stocks over the past five years underscore the inexorable fact of how returns in stock markets are explained by a few winners. Most of the listed companies have come to the stock exchange to go horizontal.

The skill of stock-picking is emphasized. Although there are hundreds or thousands of companies on the stock exchanges, most stocks are walking time bombs and value traps.

However, such comparisons are always a matter of hindsight. Five years ago, we weren't talking about the Magnificent Seven - we were talking about the FANGs. The rise of NVIDIA and Tesla to the bigger limelight was just ahead. If you look brutally at market caps, Tesla is smaller than Warren Buffett’s Berkshire Hathaway. However, Berkshire, made up of insurance, railways, and miscellaneous industrial businesses, isn’t glamorous enough for such a group of technology elite.

When looking at winning indices compiled with hindsight, it’s also worth remembering that the past is no guarantee of the future. Few companies remain among the winners from decade to decade. Of those companies, only Microsoft has hung with the stock market elite for over two decades.

Coming back to other companies, even in the United States the share indices of medium-sized and small companies have been flatlining just like Nasdaq Helsinki. Like in the United States, smaller companies trade at about 12 times the projected result. Thus, even in the US, the entire market isn’t as expensive and spectacular as it looks on the surface.

Thank you for reading the post! Read analysis and make good stock picks!