With the 1Q16 earnings season right around the corner, investors are understandably nervous given the disappointing results that have characterized the past few quarters. Additionally, conversations have increasingly focused on the effect of share buybacks since the financial crisis, and how this is likely to represent a diminished tailwind for earnings per share (EPS) this year. EPS can be decomposed into its three components – margins, revenues and share count – and while it is true that companies have been buying back stock, this has not had as much of an impact as many believe. In fact, since 2012, the reduction in share count has only boosted EPS by an average of 0.8% each year. Thus, while a decline in buybacks alone will not undermine earnings growth, rising wages are beginning to put downward pressure on margins, and lackluster nominal economic growth in the first quarter likely kept a lid on revenue growth. As a result, the outlook for 1Q earnings isn’t terribly positive, but better times may lie ahead. The macro headwinds stemming from low oil prices and a strong dollar should gradually subside over the first half of this year, which, combined with a modest acceleration in revenues on the back of rising inflation, makes the outlook for 2H16 earnings a bit brighter and suggests that there may be some upside in stocks from current levels.
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