All Cap Index & Sectors: 1Q22’s Soaring Economic Earnings Aren’t Sustainable

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Economic earnings grew year-over-year (YoY) for all two sectors through the trailing-twelve-month (TTM) for my firm’s all-cap index, NC 2000. NC2000 includes the largest 2000 US companies by market cap under my firm’s coverage. The constitution is updated on a quarterly basis (31 March, 30 June, 30 September and 31 December). I exclude companies that report under IFRS and non-US ADR companies.

This report is an abridged version of All Cap Indexes & Sectors: 1Q22 Rising Economic Earnings Not Sustainable, is one of my quarterly reports on fundamental market and sector trends. This report is based on the latest audited financial data available, which is in most cases 1Q22 10-Q. Price data as of 5/16/22.

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Economic income provides a more accurate picture of a business’s actual underlying cash flows than GAAP income.

Economic income nearly doubled in the first quarter

Economic income for NC 2000 increased from $563.4 billion in 1Q21 to $1.0 trillion in 1Q22, while GAAP income increased from $1.3 trillion to $2.1 trillion over the same time period. Economic and GAAP earnings are only slightly below calendar 2021 levels — the highest since 1998, which is the earliest my analysis is available.

However, the rising economic earnings of NC2000 are likely to reverse the trend soon.

In fact, a major headwind facing economic earnings is an increasing WACC, which ended 1Q22 in TTM and added $104.1 billion in cost of capital. The onset of rapid inflation artificially inflates GAAP earnings because profit on current sales is calculated using historical inventory costs. Once inflation calms down, the process reverses, and GAAP earnings are artificially depressed. However, investors can protect themselves from such false signals by using economic earnings to account for expected inflation reflected in the firm’s WACC.

Key details on select NC 2000 regions

While all sectors saw year-on-year growth in GAAP earnings, economic earnings for the real estate and basic materials sectors fell in 1Q22.

The energy sector saw the biggest year-on-year improvement in economic earnings to $158.0 billion, rising from $112.1 billion in 1Q21 to $45.8 billion in 1Q22.

The technology sector generates the highest economic income of any sector and grew by 30% YoY in 1Q22. On the other hand, the real estate sector has the lowest economic income and witnessed an annual decline of $1.3 billion in economic income in 1Q22.

Below, I highlight the industrial sector, which saw economic earnings improve by $54.9 billion annually in 1Q22.

Sample Sector Analysis: Industrialists

Figure 1 shows that economic income for the industrial sector increased from $5.5 billion in 1Q21 to $49.4 billion in 1Q22, while GAAP income increased from $67.7 billion to $162.8 billion over the same period.

Figure 1: Industrial Economic Income Vs. GAAP: 1998 – 1Q22

Economic earnings analysis is based on aggregated TTM data for the components of the sector in each measurement period.

The period May 16, 2022 includes financial data from Calendar 1Q22 10-Q, as this is the earliest date for which all Calendar 1Q22 10-Q for NC 2000 components were available.

Disclosure: David Trainor, Kyle Guske II and Matt Schuler receive no compensation for writing about any specific stock, genre, or topic.

Appendix: Calculation Method

I derive the economic income and GAAP income metrics above by summing the trailing twelve-month individual NC 2000 component values ​​for economic income in each region and GAAP income for each measurement period. I call this approach the “aggregate” method.

The aggregate methodology provides a direct look at the entire sector regardless of market cap or index weighting and is matched to how the S&P Global (SPGI) calculates metrics for the S&P 500.

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