The U.S. earnings season is now almost three-quarters complete and year over year profit growth of 9.5 per cent is more than double the pace expected by analysts. Chemical stocks, financials and telecommunication services have been the main drivers of growth, so that's where we'll search for investment opportunities.
At first glance, the 30 per cent earnings growth in U.S. basic materials stocks offers hope for Canadian equities. But the gains, unfortunately, are focused in multinational chemical manufacturers, not the miners where the S&P/TSX Composite is focused.
DuPont is the star of the sector after increasing earnings more than fourfold, from $0.11 per share (U.S.) to $0.59. Dow Chemical Co. doubled its profits year over year and LyondellBasell Industries saw an 87 per cent year over year growth rate.
There are three more telecom companies to note, but the big two – AT&T Inc. and Verizon Communications Inc. – have already posted strong results. Verizon profits jumped 74 per cent and AT&T generated more sedate 20.4 per cent earnings growth.
Revenue in the broad S&P 500 financials sector was terrible year over year – sales growth declined 11 per cent – but profits still managed to climb 21 per cent. This apparent anomaly was driven by two companies: Regional bank Hudson City Bancorp, and Bank of America Corp.
Bank of America reported a 94 per cent increase in profits and Hudson City grew earnings at 29 per cent. The third fastest growing U.S. bank, Keycorp, trailed well behind at 13 per cent and Citigroup posted a 14 per cent year over year decline in earnings. If we exclude Bank of America and Hudson City, sector performance was mediocre at best.
In deciding which of these sectors – chemicals, telecoms and financials – offers the best investment opportunities, the most important consideration is what valuation multiple to choose to make the comparison.
I picked forward price earnings ratio relative to history and dividend yield for the table below. Dividend yield provides a margin of safety for investors, an important characteristic in volatile markets where the economic backdrop is uncertain.
| Name | Fwd PE Ratio | Fwd PE vs 24M Average % | YoY Profit growth % | Dividend Yield |
|---|---|---|---|---|
| At&T Inc | 12.39 | 107.1997954 | 20.45 | 5.597809654 |
| Verizon Communications Inc | 13.49750359 | 109.410773 | 73.7 | 4.50691745 |
| Lyondellbasell Indu-Cl A | 11.15 | 119.399154 | 86.73 | 2.940455887 |
| Du Pont (E.I.) De Nemours | 14.76907621 | 135.4569739 | 436.4 | 2.814694508 |
| Bank Of America Corp | 12.25 | 139.276184 | 94.5 | 0.240023997 |
| Dow Chemical Co/The | 16.01712329 | 164.7520517 | 96.7 | 3.164421679 |
| Hudson City Bancorp Inc | 35.54263566 | 173.013388 | 28.6 | 1.744820026 |
Forward price-to-earnings incorporates future growth expectations and, unlike trailing P/E, allows for the possibility of a secular change in the corporate growth outlook. In other words, trailing P/E will tell us whether the stock price accurately reflects what happened last year. Forward P/E will (hopefully) indicate whether a stock is trading cheaply relative to its future growth prospects.
The U.S. telecom stocks are clearly the most attractive at current prices. They will not be the fastest growers by any stretch. But, with a forward price earnings ratio just above double the two year training average, AT&T and Verizon are most solidly in line with historic valuations. The high dividend yields – 5.6 and 4.5 per cent respectively – offer Canadian investors a U.S. dollar cash flow well above U.S. Treasuries.