Before the fourth quarter earnings reports started rolling in, Societe General analyst Andrew Lapthorne warned that investors were in for a surprise and that profits growth wasn’t nearly as strong as people were expecting. Now that the results are in, and net income was up 14% for the S&P 500 (INDEXSP:.INX) (12.8% ex-financials), you’d be forgiven for expecting Lapthorne to be eating his words. In fact, he stands by them.

2012 write-downs distort 2013 reporting

“We do not like to overly focus on pro-forma earnings beyond using them as an indicator of earnings momentum,” writes Lapthorne. “However ultimately it is growth in cash flow or operating earnings that in our view influences future investment and dividend payments.”

He argues that the net income gains are extremely misleading because 2012 was a year of heavy write-downs, and many of the biggest earnings reported for 2013 were really companies returning to form now that those write-offs no longer impact their numbers. Other growth measures paint a different, and consistent, story of 2% – 4% growth last year.

US nonfin growth 0314 MSCI

MSCI operating profits contraction

If you look at US MSCI operating profits instead the economic picture looks even worse with the US experiencing its first contraction since 2010. IBES pro-forma profits and MSCI operating profits never track each other perfectly, but the gap is a good reason for investors to be more cautious about claims that the US is in the middle of a strong economic recovery.

US MSCI contraction 0314

Capex falls negative for first time since 2010

“This disappointing growth will have economic consequences, especially versus a consensus that signals that corporates are seeing a meaningful improvement in earnings,” writes Lapthorne.

Low cash flow growth is usually accompanied by falling capex, which is exactly what we are seeing now, with capex falling negative for the first time since 2010 after outpacing cash flow for three straight years. Ironically, recent disappointing US economic data makes more sense in light of the lower growth story, and the high liquidity environment that we are still operating in and the availability of cheap financing may have a big role to play in continued stock price growth.

“With investment, capital expenditure, dividends and buybacks at almost 100% of operating cash flow, it would appear that corporate debt issuance and not cash flow holds the key to pushing equities forward at this stage and that is something we never feel comfortable with,” writes Lapthorne.

cash flow capex 0314 MSCI