Macro: Sandcastle economics
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Earnings Watch and S&P 500 shareholder yield
Peter Garnry
Chief Investment Strategist
Summary: Next week's earnings releases will offer plenty to watch but our focus is on Salesforce, Snowflake, and Coupang. In today's equity note we also take a look at the profit margin spread between the S&P 500 and the STOXX 600 indices which has declined to the lowest spread since the Great Financial Crisis. Investors care about the capital return they get from companies and we take a look at the current shareholder yield in the S&P 500 and whether that the current yield is attractive relative to the bond yield and the inflation outlook.
Earnings to watch: Salesforce, Snowflake, and Coupang
There are several interesting earnings releases next week with the most interesting being Salesforce, Snowflake, and Coupang. Activist investors have entered Salesforce over the past year and the pressure is going up on management to drastically improve profitability which is already being reflected in analyst estimates. Analysts expect revenue growth of 9.2% y/y down from 26% y/y a year and EBITDA of $2.67bn up from $1.02bn a year ago; Salesforce reports FY23 Q4 earnings (ending 31 Jan) on Thursday after the market close.
Snowflake was one of the most hot IPOs before the interest rate shock cooled the stock to being more ordinary. The cloud infrastructure company is expected to report FY23 Q4 (ending 31 Jan) earnings on Thursday after the US market close with analysts expecting revenue growth of 50% y/y down 102% y/y a year ago and EBITDA of $25mn up from $-146mn a year ago. The third company we on our most interesting to watch is Coupang because of its e-commerce exposure to South Korea which could potentially provide some colour consumer spending patterns in one of Asia’s most cyclical economies. If China’s reopening is progressing well then it should spill over into a more positive outlook for South Korea. Coupang reports earnings on Tuesday after the US market close with analysts expecting revenue growth of 7% y/y down from 34% y/y a year ago and EBITDA of $197mn up from $-248mn a year ago.
- Monday: Woodside Energy, Alcon, Occidental Petroleum, Workday, Li Auto, Zoom Video
- Tuesday: Bayer, Moncler, ASM International, Target, Monster Beverage, HP, First Solar, Coupang, Rivian Automotive
- Wednesday: Royal Bank of Canada, Beiersdorf, Reckitt Benckiser, Kuehne + Nagel, Salesforce, Lowe’s, Snowflake, NIO
- Thursday: Anheuser-Busch InBev, Argenx, Yunnan Energy New Material, Toronto-Dominion Bank, Fortum, Veolia Environment, Merck, Hapag-Lloyd, CRH, London Stock Exchange, Haleon, Flutter Entertainment, Universal Music Group, Broadcom, Costco, VMware, Marvell Technology, Dell Technologies
The Q4 earnings season is almost done and while margin compression has been an ongoing theme it is something that has been most visible in the US earnings season with the EBITDA margin declining for both the Nasdaq 100 and S&P 500 indices while it has actually increased for the European STOXX 600 Index. This play straight into our positive stance on physical related vs intangible-driven companies as explained over many quarters again in our recent Quarterly Outlook. The EBITDA margin spread between the S&P 500 and STOXX 600 is now the lowest it has been since the Great Financial Crisis.
The shareholder yield looks quite decent in S&P 500
One of the recent discussions has been over the US equity risk premium. It is long academic discussion but in simple terms it is the expected return over the risk-free rate by investing long-term in equities. In little over 200 years in the US the equity risk premium has been around 3% on average with high variance over a rolling 10-year holding period. The US equity risk premium has been somewhat higher since WWII. Many things have changed in the US equity market over time from the composition of companies in terms of capital and labour they consume, but also how capital is returned to shareholders. Historically it was dividends and almost all earnings were paid out as equities had to mimic bonds as much as possible. After WWII the dividend payout ratio declined and more earnings were retained for growth on top of an acceleration in IPOs. Later with globalisation as earnings were now earned across many different tax jurisdictions it became less tax efficient to return excess capital to shareholders through only dividends and thus the rise of share buybacks began.
If we take the past 12 months the S&P 500 companies have delivered around $67 per share in dividends and around $98 per share in share capital reduction reflecting buybacks are larger than issuances of new share capital. As of 31 January the combined value of those two stream of capital to shareholders stood at 4.1% relative to the S&P 500 price with 59% of the capital return coming from share buybacks. The current $166 per share in shareholder return is up from around $27 in January 2000 corresponding to 8.3% annualised growth in shareholder return.
If we take the figures above at face value then the required rate of return on equities would be close to 12.5% annualised which less the US 10-year yield would indicate a 8.5% equity risk premium. This is possible but is not very realistic given the evidence we have from the 1970s inflation period. In addition we do not expected dividends and buybacks to compound at the same rate. The current shareholder yield is close to the US 10-year yield and thus the expected growth in dividends and share buybacks will more or less be equal to the expected US equity risk premium. If we are conservative then we estimate dividends and buybacks to grow 4% annualised over the next 10 years. In that case the US equity risk premium is around 4%. The two stages of risk to equities
In the short-term equities remain at risk here with our current framework evolving around a two-stage impact. The first phase is the one we are in right now with the PCE core inflation for January today confirming our thesis of higher for longer. Rates markets are already reflecting this and long-term US bond yields could easily begin rising again as soon as the initial safe-haven flows are exhausted. The structural inflation discussion will heat up and scary equity markets over the coming two months.
The next phase will be in late April and May when Q1 earnings will show accelerating margin pressures as wage pressures are intensifying in the US. In addition, commodity markets are likely to be supported here by China’s reopening and the general reacceleration in the global economy instead of a recession.
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