Wall Street is inventive when it comes to terminology. Consider, for example, “sell the profit.” At first read, it may not be clear what the phrase means.
The term refers to selling stocks in the anticipation that annualized growth in corporate profits will slow down. That’s relevant now because investors anticipate weaker company earnings over the next few months, which could have a significant impact on share prices.
“Sell [stocks] because the expectation is that this is possibly the last positive earnings we will have for a couple of quarters,” says Daryl Jones, director of research at risk-management firm Hedgeye in Stamford, Conn., in explaining what the phrase means and why it is relevant now.
He has a point. This time last year corporate earnings were growing at a supercharged rate, which will be hard to surpass. For the whole year, annualized growth in operating earnings (a measure of profits with one-time costs or gains removed) for S&P 500 stocks exceeded 20%.
For the second and third quarters, the growth rate was even faster at 25% and 29% respectively, according to data from New York-based financial-analytics firm CFRA Research. Profits in the energy sector saw triple-digit percentage gains in those quarters.
The value of stocks is closely related to how fast earnings are expected to rise. When investors think that profit growth will be speedy, they tend to bid up the price of the shares. That doesn’t happen when they expect the earnings growth to slow or even contract.
That phenomenon of slowing growth affecting stocks’ values matters now because it is improbable that this year’s profits growth will be anything like as fast as was last year’s.
Consensus estimates indicate that profits per share for the second and third quarters will grow by 2% and 4%, respectively says Arthur Hogan, chief market strategist at New York-based financial firm National Securities Corp., adding that the actual results could easily vary a by a couple of percentage points higher or lower.
“The problem is that the growth gets compared versus last year’s performance,” he says. In other words, it is likely that most firms will see slowing earnings growth, which could hamper stock performance.
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