Investor Behaviour · Diversification · Financial Advice
What the Headline Earnings Number Leaves Out
A single aggregate profit figure averages away the drag of one sector and the spread beneath it, and the spread is the useful part.
One thermometer in a large building reports a single temperature. It averages the room that is freezing with the room that is fine, and describes neither. Aggregate profit figures work the same way. A quarter of corporate earnings arrives as one number, and that number is the average of hundreds of businesses having very different quarters.
The most recent quarter made the point plainly. Profit growth across the broad listed universe came in at 12% against the same quarter a year earlier. Take out oil and gas, where a sharp rise in crude compressed the margins of state-run fuel retailers, and the same set of companies grew profit at 23%. One sector removed, and the figure roughly doubles.
Breadth under the headline
How widely growth is spread matters more than how large the headline is. Of 29 sectors, 18 grew profit at double-digit rates, 7 grew in single digits and 4 declined. That distribution carries information the headline cannot. The improvement had many authors rather than two or three.
The spread held across company size as well. Excluding oil and gas, profit growth ran higher as company size fell.
| Segment | Profit growth, year on year, excluding oil and gas |
|---|---|
| Large caps | 21% |
| Mid caps | 26% |
| Small caps | 34% |
The effect accumulates. The large-cap share of profits in this universe has eased to 73% from 78% a few years earlier, while the small-cap share has risen to 10% from 8%. Nothing about that shift is dramatic in a single quarter. Over several, it changes where a market's earnings actually come from.
Same growth, different engines
Two sectors can post similar growth for unrelated reasons. Banks earned theirs from lower credit costs and steady asset quality, even as lending yields repriced faster than deposit costs and squeezed interest margins. Metals earned theirs from a price spike, with realisations rising faster than input costs, so the wider spread dropped through to profit. One is a change in credit discipline. The other is a change in commodity prices. The growth rates look alike. The durability of each is a separate question.
Margins say the same thing about averages. Aggregate operating margin outside financials contracted 275 basis points year on year to 17.5%, with raw material costs rising to 56% of sales from 51%. Excluding oil and gas, margins were broadly stable. The average moved a long way. Most of the companies inside it did not.
An average tells you where the middle landed. It never tells you why, and it never tells you how many were anywhere near it.
The practical use of breadth is what it says about dependence. Earnings resting on a wide base of sectors and company sizes behave differently from earnings resting on a narrow one, because one sector's bad quarter does less to the whole. That is a statement about the structure of a profit pool, and not a forecast about where it goes next.
The habit worth building is small. When a headline earnings number appears, look behind it for three things. How many sectors took part, whether the growth came from volume, price or cost, and what a single large outlier is doing to the average. The headline takes a second to read. The distribution takes a minute, and it is the part that describes the market.