Typically, earnings growth is more important than sales growth for stock performance. However, as the chart illustrates, this was not the case in 2024. When the market rebounded in early August after the decline in July, sales growth became more significant than earnings growth for stocks in the S&P 500. Since the beginning of August, the long-short factor return for sales growth of S&P 500 stocks, measured as sector-neutral, has increased by 10%, better than the return from momentum, which rose by 8.5%. In contrast, the earnings growth factor return has declined by 3% since the beginning of August.
This advantage for sales growth suggests optimism that expected future profits outweigh the appeal of current profit growth. For example, significant expenditures to incorporate AI developments may hinder current profit growth, but these expenditures are deemed worthwhile since they will lead to substantial profit growth later. According to this perspective, profits will follow, and it is reasonable to wait for profit growth if revenue generation remains strong.
However, markets can be impatient for profits. Based on the chart's history, the advantage of sales growth over earnings growth has not typically lasted more than half a year. Sustained optimism, bordering on exuberance, would be necessary for the sales growth advantage over earnings in 2024 to continue in 2025. A renewed reward for earnings growth would create a healthier backdrop for the market rally to continue since it would reward the substance of profit growth over a bet on future profit growth. That's a signal worth monitoring.
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