The U.S. stock market has seen company profit margins shrink consistently over the past two years, but they remain “solid” for the S&P 500 while estimates for the information-technology sector appear to be holding up relatively well, according to DataTrek Research.
“The last few years have been remarkably good for this sector, and yet they continue to show the second highest margins of any S&P group” in the second quarter, said Nicholas Colas, co-founder of DataTrek, in a note emailed Tuesday. “While Tech’s net margins are down modestly versus the 5-year average,” he found “they are holding in well.”
In the chart below, Colas highlighted how S&P 500 profit margins estimated at the sector level for the second quarter are faring relative to the broad stock-market index, based on comparisons with each sector’s five-year average. His note cites FactSet as the source for the chart.
Companies this month have been reporting their second-quarter earnings results. The chart shows the tech sector’s net profit margins are estimated at 22.4% for that earnings period, compared with a five-year average of 23%.
Meanwhile, the broad S&P 500 has seen its margins decline to 11.1% in the second quarter from a high of 13% in the same period two years earlier, according to the DataTrek note. The margins are now about the same as the 5-year average of 11.3 percent for the index.
“No wonder the S&P 500 is still 5 percent away from its all-time high, set over 18 months ago in early January 2022,” said Colas. “Margins have been solid – anything over 10 percent is still great – but they certainly have not been stable.”
The S&P 500
SPX,
was trading up 0.3% around midday Tuesday at about 4,566. The index closed Monday at 4,554.64, off 5% from its record close of 4,796.56 on Jan. 3, 2022, according to Dow Jones Market Data.
“Industrials are showing the best margin comps versus the prior 5-year average,” up 2.5 points in the second quarter, said Colas. And from a valuation standpoint, “the group remains cheaper” than the 5-year average for its price-to-earnings multiple, he found, citing 19.1x vs. 19.4x.
While that track record is “enough” to support the sector’s recent rally, “we doubt industrials can see a large secular improvement in their valuation until they get through a recession with similar levels of profitability,” said Colas.
The chart highlighted in the DataTrek report shows that healthcare “is seeing the largest negative comparison in net margins now to its 5-year average.” Healthcare margins have declined 2.8 points to 7.6% versus their five-year average of 10.4%, according to the note.
“If we were in a risk-averse market environment, that might not matter too much,” said Colas. “In an uptrending market, it absolutely does.”
The S&P 500’s tech sector
SP500.45,
is up almost 46% so far this year, while the industrials group
SP500.20,
has rallied more 11% and healthcare
SP500.35,
is about flat with a 0.1% dip year to date, FactSet data show, at last check. Tech is the index’s best-performing sector in 2023, driving the S&P 500’s year-to-date gains of around 19% based on midday trading Tuesday.
Read the full article here
