The profit margins of companies in the U.S. stock market have been consistently shrinking over the past two years, with one exception. According to DataTrek Research, the information-technology sector is maintaining relatively solid profit margins compared to other sectors of the market.
Nicholas Colas, co-founder of DataTrek, noted that while the tech sector’s net margins have decreased slightly compared to the five-year average, they are still performing well. In fact, they have the second highest margins among all S&P groups for the second quarter.
To illustrate this, Colas presented a chart comparing S&P 500 profit margins at the sector level for the second quarter to each sector’s five-year average. The chart, sourced from FactSet, shows that the tech sector’s estimated net profit margins for this quarter are 22.4%, slightly lower than the five-year average of 23%.
In contrast, the broader S&P 500 has experienced a decline in profit margins, dropping from 13% in the second quarter two years ago to 11.1% in the current period. These margins are now in line with the five-year average of 11.3%.
The decline in profit margins is one of the factors contributing to the S&P 500’s current position, still 5% away from its all-time high set in early January 2022. Despite this, Colas emphasizes that margins above 10% are still considered solid, even if they have not been completely stable.
Overall, while the stock market as a whole has seen declining profit margins, the information-technology sector has managed to maintain its profitability.
The Current State of the S&P 500
The S&P 500 is experiencing some positive movement, with a 0.3% increase around midday on Tuesday, reaching approximately 4,566. This comes after closing at 4,554.64 on Monday, which was a 5% decrease from its record high closing of 4,796.56 on January 3, 2022, according to Dow Jones Market Data.
Industrials Sector Highlights
When looking at the industrials sector, it is showing promising results in terms of margin comparisons. The second quarter has seen a 2.5 point increase in margin comps compared to the prior 5-year average, as stated by Colas. Additionally, from a valuation perspective, the group’s price-to-earnings multiple remains cheaper than the 5-year average, with a ratio of 19.1x versus 19.4x.
However, Colas believes that although these factors support the recent rally in the sector, a significant improvement in valuation may not be possible until they successfully navigate a recession with similar levels of profitability.
Healthcare Sector Challenges
A chart highlighted in the DataTrek report emphasizes that the healthcare sector is currently experiencing the largest negative comparison in net margins compared to its 5-year average. The margins for healthcare have declined by 2.8 points, reaching 7.6% compared to the five-year average of 10.4%.
While this may not be a significant concern in a risk-averse market environment, it becomes more relevant in an uptrending market.
Sector Performance in the S&P 500
Based on the latest data from FactSet, the tech sector in the S&P 500 has been performing exceptionally well, with an almost 46% increase year-to-date. Meanwhile, the industrials group has seen a rally of over 11%, and the healthcare sector has remained relatively flat with a slight 0.1% decrease.
It is important to note that the tech sector is currently the best-performing sector in 2023, driving the S&P 500’s overall gains of approximately 19% based on midday trading on Tuesday.
