Just like the hit series “Scandal” in which a political “fixer” delves into the manipulation, deceit and obfuscation that prevails in the dark corners of Washington, D.C., so to has Wall Street’s earnings. From time to time, I analyze the previous quarters earnings for the S&P 500 to reveal the “quality” of earnings rather than the “quantity” as focused on by Wall Street.
One of the most interesting data points continues to the be the extremely low level of “top line” revenue growth as compared to an explosion of the bottom line earnings per share. This is something that I have dubbed “accounting magic.” As shown, since 2009 total revenue growth has grown by just 34% while reported earnings have skyrocketed by 204%. How does that happen?
As I have discussed previously:
“Since 2000, each dollar of gross sales has been increased into more than $1 in operating and reported profits through financial engineering and cost suppression. However, it is important to note that benefits from such actions are finite.”
While the BEA scrambles to adjust Q1-GDP higher with a second round of seasonal adjustments (read more here), the plunge in corporate profits suggests that Q1 was indeed as weak as portrayed. As shown in the chart below, there is a high degree of correlation between the wages/profits ratio and economic growth. It is worth noting that until financial engineering took hold in 1990, the economy grew faster than wages/profits. Since 2000, the wages/profits ratio has become detached from all reality.
This detachment leads to another problem that is arising for investors — valuations.