A recent paper from Fidelity Investments indicated that U.S. corporate earnings can sustainably continue to grow in coming years, driving performance of U.S. equity markets.
In the third quarter, aggregate corporate return on equity for S&P 500 companies was 14.1 percent, slightly higher than the index’s 13.6 percent long-term average, according to the paper. Between 1990 and 2013, the maximum trailing annual return on equity for the S&P 500 was 18.8 percent, and the minimum was 4.1 percent, indicated potential for further upside.
The paper also showed that, over the past decade, overseas sales accounted for more than 40 percent of total revenue at S&P 500 companies, a trend that could drive earnings. The emergence of a middle class in emerging economies and recent economic stabilization may support future profit growth.
As a result of new capital regulation, merger and acquisition activity has been subdued, and overall capital expenditures as a percentage of sales have remained moderate. Additionally, corporate cash levels are higher, despite increased share buybacks and dividend payouts, and the paper said a continuation of regulatory pressure could boost earnings.
After 2008, stocks rose 106 percent through September 2013, coinciding with a 111 percent rise in corporate earnings. In December 1999, the equity market’s price-to-earnings ratio was 28.4 percent, implying unsustainable earnings growth.
At the end of 2008, the trailing P/E ratio was just 18.2, below the historical average of 19.5. Currently, the equity market’s valuation is somewhat below the long-term average, despite significant growth in the past few years, indicating that investors can expect moderate earnings growth.