Corporate Earnings of the S&P 500’s Top 10: Why It Is Important for You

July 29, 2016

Corporate Earnings of the S&P 500’s Top 10: Why It Is Important for You

  • Corporate earnings and fundamentals are variable, pick the stocks that best suit you.
  • There are low PE ratio stocks, high growth stocks, and high dividend yielders – anything you might want.
  • But be aware: some companies engage in buybacks that are detrimental to shareholders’ value.

Introduction

When you add up the top ten companies by weight, they account for 17.7% of the total weight of the S&P 500. For investors who are heavily invested in the S&P 500, following the earnings of its top ten companies is essential in order to understand the risks and rewards of being invested in the index. In this article we are going to assess the current market situation by looking at what has been going on with the 10 biggest companies in the S&P 500 index.

Apple

Apple (Nasdaq: AAPL) reported earnings after hours on Tuesday. Q2 2016 revenue declined 14.4% year-over-year and earnings per share declined 27% to $1.42 from $1.85. Those results were better than expected, and AAPL jumped 7% in after-hours trading.

AAPL isn’t a standard company, its revenue is highly dependent on iPhone sales which fell due to customers awaiting a new generation iPhone to be announced in September. If the same trend holds true as it has in the past with new iPhone generation sales, AAPL’s sales will increase when it releases the new phone. In the meantime, perhaps the most important thing from this earnings report is the fact that AAPL returned $13 billion to investors through dividends and repurchases.

The dividend yield is 2.38% annually but when we add in the repurchases, it comes to a staggering 2.3% quarterly yield, making AAPL’s dividend yield quite a bit higher than the S&P 500 average of 2.05%.

In total, the S&P 500 buybacks were $161 billion in Q1 2016,—interestingly, Apple alone makes up about 8% of this total— second only to Q3 2007 when the buybacks reached $172 billion. The most important thing with buybacks is the question: is buying your own stock the best use of cash at that point in time? Yes, companies protect and increase their share prices, but at what cost? We all know what happened in the two years after Q3 2007 when repurchases reached record highs…

Another company that is strong in repurchases in Microsoft (Nasdaq: MSFT).

Microsoft

MSFT also saw its revenue decline, by 6%, and earnings per share declined 23% (GAAP results), but nevertheless returned $2.8 billion in dividends and $3.6 billion in repurchases, giving a dividend yield of 2.54% and a 3.1% indirect yearly repurchase yield.

The decline in revenues and earnings further exacerbates the above mentioned buyback issue, but even more alarming is the fact that MSFT is buying its stock despite their PE ratio of 27.7, while AAPL’s is at 11. This is where alpha kicks in because good stock picking can make you avoid such bad cash investments.

Exxon Mobil

The consensus earnings per share for Exxon Mobil (NYSE: XOM) is $0.64 for Q2 2016 which is 34% below the earnings per share in the same quarter last year.

XOM’s share repurchase program is another crazy example of ill-timed purchases. In February, XOM stopped its buyback program after spending $210 billion over the last decade. The craziness lies in the fact that the company has stopped buying back stocks despite the price being at multiyear lows.

figure 1 xom buybacks
Figure 1: XOM’s stock price movement in the last 2 years. Source: Yahoo Finance.

This falls perfectly in line with what usually happens as managers time buybacks poorly. When stocks are cheap, management doesn’t buy them. When they are expensive, buybacks explode, eroding shareholders’ value.

figure 2 total buybacks
Figure 2: Quarterly share repurchases and number of companies repurchasing shares. Source: FACTSET.

Johnson & Johnson

Johnson & Johnson (NYSE: JNJ) is continuing on its wonderful ascent despite revenues and earnings per share not growing since 2014. JNJ has a $10 billion share repurchase program that is being financed by debt. The current enthusiasm is of course backed by global monetary easing which pushes future expectations higher.

General Electric

General Electric (NYSE: GE) has survived terrible times in the last 7 years. GE’s revenue is currently just 64% of its 2008 revenue, but the company finally managed to increase earnings and revenue in the last quarter. The PE ratio is still high at 24, and J.P. Morgan warns that GE will face bad times again due to the volatility in the economy and other internal issues.

Amazon and Facebook

Amazon (NASDAQ: AMZN) and Facebook (NASDAQ: FB) have the growth that the companies discussed above are missing, but it comes at crazy valuations.

AMZN’s PE ratio is 303, while FB’s PE ratio is 74.5. We cannot know if AMZN will manage to grow its earnings by more than tenfold in order to reach a more normal valuation or if it will forever stay the mega growth company.

Holding the S&P 500 gives you diversification, the unfortunately you gain exposure to companies after their initial growth cycle has passed. AMZN’s weight in the S&P 500 was only 0.46% in 2009 when its price was about a tenth of its current price.

Berkshire Hathaway

Berkshire Hathaway (NYSE: BRK.A, BRK.B) hasn’t yet release its earnings but what is significant and different from the above companies is that buybacks are limited. BRK will buy back its own stocks only if the price falls below 1.2 times book value. Warren Buffett believes that buying back the company’s own shares above book value is a disservice to shareholders. This might be one of the reasons why BRK has by far outperformed the S&P 500 in the last 30 years.

figure 3 brk vs sandp
Figure 3: BRK vs the S&P 500. Source: Yahoo Finance.

AT&T

AT&T (NYSE: T) doesn’t have comparable earnings as it recently acquired DirectTV, however it is a company that keeps on growing, has a high dividend yield of 4.53%, and has had minimal share repurchases when compared to other companies in the last 4 quarters.

JPMorgan Chase & Co

The last company on our list is JPMorgan Chase & Co (NYSE: JPM). JPM reported revenues up by 4% and net income up by 5%, and has a PE ratio of 10.87 with a price to book ratio of 1.0, making it the company with the best fundamentals on our list and a great introduction to our conclusion.

Conclusion

Most great investors would advise the average investor to hold the S&P 500 for the long term, but the analysis of the 10 companies we’ve discussed and the variety of their revenue growths, earnings, and management buyback policies suggest something different.

Being long the S&P 500 just because that’s what everyone else does means also having managers destroy shareholder value by excessive and poorly timed buybacks, or it means paying high valuations for companies with no growth or exorbitant valuations for growth companies. On top of that, the risks of just owning the S&P 500 are increasing as its valuation is higher and is at levels only seen twice historically, in the dotcom bubble and just before the 2009 crisis.

figure 4 s&P 500 pe ratio
Figure 4: S&P 500 PE ratio. Source: Quandl.

Investors should assess their own needs and financial requirements. There are plenty of relatively safe high dividend yielders on the market, value companies, growth companies and declining companies from which to build your portfolio.