U.S. corporate earnings outlook

Corporate earnings have proven resilient so far in 2019. And this growth is expected to continue throughout the year, according to Paul Roukis, managing director and portfolio manager at Rothschild Asset Management in New York.

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Expectations at the beginning of the year were for year-over-year earnings to decline by a few hundred basis points in the first quarter, Roukis said in a May 14 interview.

“The good news is that didn’t happen. We are largely through earnings season and the scorecard would show about 75% of companies exceeding expectations.”

Instead of a modest contraction, first quarter earnings growth was around 2% to 3% year over year, he said.

And while company management teams remain cautious until the outcome of events such as trade negotiations, Roukis said that, “barring any unexpected shocks to the system,” companies should be able to deliver upwards of 5% earnings-per-share growth for the year.

A healthy U.S. economy, employment gains and benign inflation contribute to the outlook, Roukis said. The U.S. economy grew by 3.2% in the first quarter, beating market expectations of 2%, and unemployment declined to 3.6% in April.

As for valuations, the forward-looking price-to-earnings (PE) multiple for U.S. equities is about 16.5, he said.

“With low interest rates, low inflation and a generally healthy economy, a PE multiple in the mid to high teens seems pretty reasonable, though not likely to expand much from current levels,” said Roukis, whose firm manages the Renaissance U.S. Equity Value Fund.

“That is why we think corporate profit growth is essential to further market gains from here, and why it’s also important to keep an eye on inflation and central bank monetary policies.”

Stock to watch in 2019

Roukis likes investment management company Charles Schwab, whose market cap is around $54 billion.

“The business model has transitioned from being a pure retail brokerage to a diversified financial services company that includes financial advisory and banking services,” he said. “The company also serves as a back office for independent financial advisors.”

Traditionally, Schwab—with total client assets of about $3.6 trillion—has organically grown its net assets by roughly 6% per year, he said.

“Earnings are projected to grow about 13% in 2019, with current expectations of 8% growth in 2020,” Roukis said.

Further, Schwab can accelerate returns to shareholders through 2020. “The company recently raised its dividend and has a $4-billion share buyback authorization, which essentially represents about 7% of total market cap.”

Also, the firm has a low-cost expense structure, “which provides a competitive advantage in such a price-sensitive industry,” said Roukis.

However, the stock is procyclical and dependent on macro factors. “The ideal backdrop would consist of a strong economy, active and rising equity markets, and positively trending interest rates,” he said.

The company is exposed to interest-rate volatility due to its growth in banking operations.

“The interest rate backdrop has not been viewed that positively,” said Roukis. “The stock sold off about 30% from its highs in 2018 in the aftermath of the Fed’s policy shift. In essence, investors felt the company was over-earning in the near term, and that pre-tax margins in the mid-40% range are not sustainable.”

But when the stock traded down to 14 times earnings—the cheapest it’s been in a decade—Roukis thought it was trading at a discount. Schwab is often traded at roughly 20 times forward-looking earnings, he said, so it was “a significant discount to where the stock has historically traded, even assuming that earnings could be cut.”

A year ago, Schwab was trading above US$58. During the height of December’s selloff, it dipped below US$40 but rose above US$47 earlier this year. It has since dipped again and is trading in the US$40 range.

Roukis added, “We recognize and appreciate the interest-rate market sensitivity, which would put the company at some risk in the near term. However, we are comfortable taking that risk given the discounted valuation, and our view that the company is a secular winner in the asset-gathering game.”

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