Labor Costs Are Catching Up With S&P 500 Companies

In the first quarter of 2022, rising labor costs are beginning to catch up with S&P 500 companies. As a result, it is frequently mentioned in conference calls that follow earnings reports.

Labor costs are having a negative impact on the Q1 earnings of the majority of firms that have reported earnings thus far, far more than other factors like Covid-19, the Russian-Ukraine war, and the rise in the price of raw materials.

That's according to FactSet, which closely monitors the financial reports, conference calls, and management narratives of the S&P 500 firms to identify the factors that shape corporate profitability every quarter.

Specifically, 65% of the 20 S&P 500 companies that have reported earnings as of last week have cited the negative impact of labor costs on Q1 earnings.

"Labor costs and shortages have been cited by the highest number of companies in the index to date as a factor that either had a negative impact on earnings or revenues in Q1 or is expected to have a negative impact on earnings or revenues in future quarters." said John Butters, vice president and senior earnings analyst at FactSet. "Of these 20 companies, 13 (or 65%) have discussed a negative impact from this factor. After labor shortages and costs, COVID costs and impacts (12) and supply chain costs and disruptions (12) have been discussed by the highest number of S&P 500 companies."

Nonetheless, companies are still reporting a strong earnings growth, meaning that the majority of these companies have the power to pass the rising costs on to consumers by hiking prices, at least for now.

"It is interesting to note that despite the negative impacts cited by these 20 companies, they have reported aggregate (year-over-year) earnings growth of 18.5% and average (year-over-year) earnings growth of 22.7%," adds Butters. "It appears most of these companies are raising prices to offset these negative impacts, as 18 of these 20 companies (90%) discussed increasing prices or improving price realization on their earnings calls."

These findings are consistent with inflation figures released this week, which showed that the Consumer Price Index, a measure of prices consumers pay at the retail level, rose at an annual rate of 8.5% in March. That's well ahead of a 7.5% increase in labor hourly compensation over the same period. And that’s good news for investors in S&P 500n companies.

Still, the FactSet findings should be interpreted with caution for several reasons. First, they are based on a sample of 4% of the companies included in the S&P 500 index. Second, S&P 500 are large companies usually operating in oligopoly markets, where they have the power to raise prices. That isn't the case with smaller companies, which operate in highly competitive markets, so they can't raise prices as conveniently as larger companies.

In addition, smaller companies are usually more affected by local government regulations, which add to the cost of doing business, and therefore are expected to get a more significant hit on their profitability.