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Earnings Outlook

The following is an excerpt from this week's Earnings Trends article.  To see the full article, please click here.

Q1 Earnings Season Off to a Weak Start

The 2014 Q1 earnings season has gotten off to a relatively soft start. Low expectations essentially guarantee that we are unlikely to get any major negative surprises. But as with economic data, the market has likely moved past the Q1 numbers and is looking ahead to the coming periods when earnings growth is expected to accelerate.

A big part of the reports thus far have been from the Finance sector, with results from more than one-third the sector’s total market capitalization are already out. Most of the Finance sector results have been from the major banks, which alone account for more than 40% of the Finance sector’s total earnings.

Estimates for bank earnings had fallen ahead of the start of the earnings season as it became clear that weakness in the capital markets business will compound the existing mortgage banking woes. The capital markets business, particularly on the fixed income side has been weak for a while and we will likely see a continuation of that trend in Q1, with fixed income revenues offsetting gains on the advisory sides. We saw this with J.P. Morgan (JPM - Analyst Report), Bank of America (BAC - Analyst Report) and even Citigroup’s (C - Analyst Report) otherwise better-looking report couldn’t hide this issue. The ever present legal/compliance costs also don’t seem to be going away either and have effectively become a recurring part of the business model.

The table below shows the Q1 earnings scorecard for the component (medium level) industries in the Finance sector. As you can see, the earnings season is almost over for the Major Banks industry, with 86.7% of the industry’s total market capitalization already reported Q1 results.

 

The table below compares the results thus far for Finance sector industries with what we saw from the same industries in the preceding quarter and the 4-quarter average.

 

The weak results at Bank of America are a big reason for the Q1 earnings decline for the Major Banks industry. But even excluding the company, the industry’s Q1 results are weaker than what we have been seeing in recent quarters. Even the beat ratios, both earnings as well as revenues, are weaker than in other recent quarters.

Overall Q1 expectations remain low, with total earnings for the S&P 500 expected to be down -4.0% from the same period last year on +1.3% higher revenues and modestly lower margins. As has been the trend for more than a year now, estimates for Q1 came down sharply as the quarter unfolded. The current -4.0% decline in total Q1 earnings is down from +2.1% growth expected at the start of the quarter in January.

With two-thirds of S&P 500 members typically beating earnings estimates in any reporting cycle, actual Q1 results will almost certainly be better than these pre-season expectations. But Q1 is unlikely to repeat the performance of the last few quarters when we would witness new all-time records for total earnings each quarter.

Guidance has been overwhelmingly weak for more than a year now, keeping the revisions trend firmly in the negative direction. Odds are that we wouldn’t see any change on that front this earnings season either, bringing down estimates for the rest of the year. Investors haven’t cared about negative estimate revisions thus far, but it will be interesting that behavior will remain in place going forward as well.


Key Points

  • The 2014 Q1 earnings season has gotten underway with results from 47 S&P 500 members (with fiscal quarters ending in February) already out. The reporting cycle gets into high gear from next week onwards.
  • Total earnings for the 47 S&P 500 companies that have reported results are down -4.7%, with 63.8% beating earnings expectations. Revenues for these companies are up +0.7%, with a revenue ‘beat ratio’ of 42.6%. The performance from these companies is weaker than what we have seen from this same group of companies in recent quarters.  
  • For the S&P 500 companies as whole, total Q1 earnings are expected to be down -4.0% from the same period last year, on +1.3% higher revenues and 51 basis points in lower margins. Sequentially, total earnings for the S&P 500 are expected to be down -7.6%.
  • Estimates fell sharply as the quarter unfolded, with the current -4.0% decline in total earnings down from expectations of +2.1% positive growth in early January.
  • The growth weakness is broad-based and not concentrated in any one sector, with 10 of the 16 Zacks sectors expected to show earnings declines in Q1. Among the major sectors, earnings are expected at this stage to be down -7.3% in Finance, -6.9% in Technology, -9.0% in Energy, and -14.4% in Autos. Business Services and Utilities are the only sectors expected to show double-digit earnings growth.
  • The Q1 earnings season is expected to be the low point of this year’s earnings picture, both in terms of total earnings as well as the growth rate. Total quarterly earnings reached an all-time record in 2013 Q4, but are expected to fall short of that level in 2014 Q1. Expectations for the coming quarters reflect a strong ramp up, with each of the following three quarters a new all-time record.
  • Guidance has overwhelmingly been negative in recent quarters and we saw the same trend in place with the initial Q1 reports. Continuation of that trend through the rest of this earnings season will result in the by-now all-too-familiar negative revisions to estimates for 2014 Q2.
  • Total earnings in Q2 are currently expected to be up +4.4%, followed by growth rates of +6.4% in Q3 and +8.8% in Q4. For the full year, total earnings are expected to be up +6.9% in 2014 and +11.9% in 2015.
  • The bottom-up ‘EPS’ estimate for the S&P 500 for 2014 currently stands at $115.66, while the top-down estimate for the same is currently at $117.80. For 2015, the bottom-up estimate remains $130.57, with the top-down estimate from Wall Street strategists currently at $125.

To see the full Earnings Trends report, please click here
 

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