Corporate America’s Earnings Quality Is the Worst in Three Decades
In telling their stories about how the future is bright for stocks, bulls point to solid earnings to justify the optimism. But cracks are forming in that narrative — in the trajectory of profits, and just as worryingly in the makeup of the profits themselves.
In a potentially ominous development, earnings across US industries have started to expand noticeably faster than cash is coming in the door. Income at S&P 500 companies, adjusted for amortization and depreciation, topped cash flows from operations by 14% in the year through September, according to data compiled by UBS Group AG that excludes the index’s financial and energy firms.
In other words, for every dollar of profits, only 88 cents was matched by cash inflows, the largest discrepancy since at least 1990. One way this happens is when money owed to companies is booked as sales before payment actually arrives, a perfectly acceptable accounting treatment that nevertheless stirs anxiety when it’s trending in this manner. Another way is when the cost of producing goods understates the cash being consumed as inventory builds.
Rather than an indication of bad management behavior, the widening gap likely highlights a harsh business environment, raising questions over the reliability of the corporate resilience stock bulls like to highlight. While financial results largely came in better than expected last quarter, the number of loss-making firms is hovering near a record high. With the Federal Reserve aiming to slow demand in its inflation-fighting campaign, companies are increasingly in a position where earnings may not present the whole picture of their financial state.