If stock investors seem antsy, perhaps it’s because a long stretch of easy earnings growth for U.S. companies is coming to an end. Meanwhile, there’s an historical footnote: Four American technology giants could soon pass Saudi Aramco to become the world’s most prosperous companies, beginning with one in a matter of weeks.
I plan to feign enough outrage to not run afoul of rising antiplutocratic sentiment, while quietly rooting for the home team.
First, the broad market. Third-quarter reporting season for S&P 500 index companies shifts into gear next week with reports from more than a half-dozen big banks. Covid broke a long-established pattern whereby analysts lowered estimates leading up to reporting time, and companies announced upside “surprises.” For five quarters running, estimates have climbed rather than fallen ahead of earnings season, and during the past four, companies still beat them. That’s because the strength of consumer spending during the pandemic has been genuinely surprising.
But the trend is slowing and may be ending. During the third quarter, S&P 500 earnings estimates rose just 2.9%, less than half the increase of the past two quarters. And broken down monthly, they rose 3.8% over July and August, and then fell 0.9% in September. That’s not a big drop, but it’s the biggest since June 2020, before vaccinations began turning things around.
That raises the question of whether inflation and shortages will sap growth around the same time that easy comparisons with hard-hit Covid quarters are ending. Last quarter, earnings bounced back more than 80%. As things stand now, they’re expected to rise 28% in the third quarter, and 22% in the fourth, before suddenly slowing to 6% and 4% growth in the first two quarters of next year. If estimates fall below that, stock buyers could lose enthusiasm, with the S&P 500 priced at 20 times next year’s earnings.
Then again, near-zero interest rates have persuaded investors to pay remarkable prices for assets with no earnings at all. If Bitcoin is worth its current $55,000, who’s to say the S&P 500 isn’t a bargain?
Now, Big Tech. On Oct. 28, Apple (ticker: AAPL) will report results for its fiscal year ended in September, and it could show free cash flow of more than $100 billion. The only company in that league is energy monopoly Saudi Aramco (2222.Saudi Arabia). Within three years, Apple could be joined by Microsoft (MSFT), Amazon.com
(AMZN), and Alphabet (GOOGL).
I realize that America’s tech titans face a popular backlash. I’m as outraged as anyone over the power these robber barons have amassed by delighting me with discount package deliveries, instantly answering all of my questions online, and putting a workstation, entertainment center, and photo lab in my pocket.
But if we’re comparing, Aramco is a price colluder that has contributed an estimated 4% of the planet’s carbon-dioxide emissions over the past half-century, and provides the bulk of funding for the family that controls what Freedom House calls the world’s seventh least-free country. I’m no expert on how the ethical-industrial complex keeps score, but I’m pretty sure that a couple of those warrant deductions.
I want to be fair: It says right there on page seven of the annual report that “Aramco recognizes that environmental, social, and governance (ESG) factors are a rising priority for investors today.” But if I’m stickling, page three is devoted to a photo of the crown prince, who the U.S. Central Intelligence Agency says ordered the murder of a dissident journalist in 2018. The kingdom denies any involvement.
But enough about E, and S, and G, and whatever category that last one falls under. My focus here is profits. There are only two companies that can be said to have earned $100 billion in a single year, and one doesn’t count. Vodafone Group (VOD) is a British telecom whose top financial boast over the past 25 years is having held a stake in Verizon Wireless for 15 of them. It sold in 2014 to Verizon, and recorded a massive gain.
Not counting Vodafone leaves Aramco, which earned $111 billion in 2018 from core operations, with a boost from a rising oil price and a cut in the tax rate paid to the Saudi government from 85% to 50% ahead of a late-2019 initial public offering.
After a Covid plunge for crude oil, prices are now back up, and Aramco is expected to earn profits over the next four years that hover at $102 billion to $111 billion. The ultimate prize for companies isn’t profits, but rather free cash flow, the real, spendable cash companies clear after all costs are paid. For Aramco that measure is a bit lower, owing to elevated capital spending. It’s seen approaching but not topping $100 billion in the years ahead.
If distant forecasts for Apple are to be believed, it will produce minimal free cash growth from here. But the rest of the bunch will see rapid increases for years. Microsoft is starting from a base of $56 billion in its year ended in June, and Alphabet, an estimated $68 billion in this calendar year. Amazon is on a spending tear this year, but next year’s free cash is pegged at $50 billion, and early guesses for the years after that put the growth rate at over 40%.
What these companies have in common is that analysts, on average, predict they will hit $100 billion in free cash flow sometime in 2024. We’ll see whether that pans out. Facebook (FB), the most despised giant of the moment, and perhaps for good reason, is a relative runt here, with free cash expected to barely top $70 billion by then.
It’s just as well. Four Aramcos is a lot. Five seems excessive.
Write to Jack Hough at [email protected]. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.
