S&P 500 net profit margins hit record 14.8% as earnings surge 28.8%

S&P 500 net profit margins hit a record 14.8% in the first quarter, giving bulls cover for elevated stock valuations.

The S&P 500's net profit margin rose to 14.8% in the first quarter, the highest since FactSet began tracking the metric in 2009.

"This is a productivity-driven environment, much like the 90s were, and productivity is spreading across sectors," Nancy Tengler, chief executive of Laffer Tengler Investments, said.

The earnings growth rate for companies in the index surged 28.8% in the first quarter, the fastest pace since the fourth quarter of 2021. Excluding the technology sector, the S&P 500 would have reported a net profit margin of 12.4%, according to John Butters, senior earnings analyst at FactSet. Multiple sectors including financial services and industrials reported net margins above their five-year averages.

The record margins provide fundamental support for a market trading at about 20 times forward earnings, above the 10-year average of 19 times. Analysts project a second-quarter net profit margin of 14.2%, which would trail the first quarter's record but exceed the year-ago figure of 12.9% and the five-year average of 12.3%.

The margin expansion is broad-based but tech-driven. Chip makers such as Nvidia and Micron Technology are pocketing massive profits from the AI infrastructure buildout, while some hyperscalers building out data centers face margin compression from hundreds of billions in capital spending.

Goldman Sachs chief U.S. equity strategist Ben Snider called the upcoming second-quarter earnings season "a critical test" for U.S. stocks. The bank raised its year-end S&P 500 target to 8,000 from 7,600 in May, projecting 2026 earnings per share of $340, representing 24% year-over-year growth. FactSet estimates S&P 500 second-quarter earnings growth at 22%, with revenue growth expected at 12.1%, the strongest pace since the second quarter of 2022.

"Continued earnings growth should drive continued equity market upside," Snider said.

Some companies are raising prices to protect margins. Apple increased prices on its products to offset surging costs of memory and storage chips, Chief Executive Tim Cook said in an interview with the Wall Street Journal. Conversely, OpenAI is considering slashing prices it charges users to win customers from rival Anthropic, the Journal reported, highlighting the risk of a pricing reversal in the technology sector.

Risks to the Margin Story

The concentration of margin expansion in technology poses a risk. The seven largest technology stocks — Nvidia, Apple, Alphabet, Microsoft, Amazon, Broadcom and Meta — post a collective return on equity of 44%, up nine percentage points over the past three years. Goldman estimates their ROE will fall by an average of 700 basis points next year as depreciation at hyperscalers increases.

Profit margins could also face pressure from tighter financial conditions. After the Federal Reserve signaled continued commitment to price stability under new Chairman Kevin Warsh at its June meeting, traders increased the probability of an interest-rate increase by the end of the year. Higher borrowing costs would squeeze margins across the economy.

The S&P 500 is trading near 7,365 after a technology-driven selloff. Goldman's 8,000 target implies about 9% additional upside from here, contingent on earnings delivery. The second-quarter reporting season, which begins in mid-July when major banks report results, will test whether profit margins can hold near record levels against elevated expectations.

This article is for informational purposes only and does not constitute investment advice.