The Canadian stock market has enjoyed two years of profit-margin expansion, and has its sights set on a third. But it's becoming clear that some sectors have become more exhausted from the ride than others.
Upcoming research from National Bank Financial - from which chief strategist Stéfane Marion and economist Marco Lettieri were kind enough to afford us some advance data - has found that overall S&P/TSX composite index profit margins don't look particularly stretched by historical standards, and Bay Street's analysts still expect healthy margin gains for 2011. But unlike the earlier stages of the margin expansion, the gains will no longer be across the board.
In fact, there is considerable divergence on the horizon among the industry sectors that make up the S&P/TSX - a divergence that could emerge as a key factor in the relative performance of the sectors in the coming months.
The writing in the margins
NBF crunched the stock-by-stock sales and operating-earnings estimates from analysts to come up with consensus profit-margin expectations for the entire S&P/TSX composite, and then looked at how the numbers broke down among the 10 major sectors. While they found a consensus call of a substantial 20.3-per-cent rise in overall margins for the entire index for the year, the breakdown revealed huge discrepancies among the sectors.
Dominating the expectations are the resource sectors - a 36-per-cent forecast jump in margins for the materials sector, and 11 per cent for energy stocks. It's hardly surprising, given the rise in underlying commodity prices that has been fuelling strong profit expectations in resource stocks.
The information technology sector, on the other hand, is looking at an estimated 12-per-cent contraction in profit margins this year. Utilities also face a small contraction, likely a symptom of rising fuel costs.
The source of bifurcation?
The diverging profit-margin pictures could be playing a key role in the widening "bifurcation" in stock valuations that UBS Securities Canada strategists George Vasic and Garry Cooper identified in a recent research report.
The strategists noted that 2011 price-to-earnings multiples span an unusually wide range of eight multiple points from highest to lowest, and only two of the sectors are within one multiple point of the P/E for the S&P/TSX as a whole.
A look at those sectoral P/E multiples shows a considerable similarity to the sectoral divergence of margin expectations. Materials and energy are among the higher P/Es in the market, while information technology is at the bottom of the pack.
Curiously, financials - which have among the highest margin-growth expectations - are near the bottom of the P/E list, while utilities are near the top. These could be areas where the stock valuations haven't yet adjusted to the realities of future profit growth - and could signal areas where the market will need to re-price in the coming months.
David Parkinson