The following is an excerpt from this week's Earnings Trends article. To see the full article, please click here.
An Improving, But Still Weak Earnings Picture
Our initial call about the Q1 earnings season being extremely weak and outright mediocre has turned out to be a bit premature. With a bigger and more balanced sample of reports at our disposal now, the Q1 earnings picture isn’t looking as bad. We are not suggesting that the earnings picture has suddenly turned around; it hasn’t. There is still not much earnings growth, top-line surprises are for the most part negative and there is no change on the guidance front.
What has changed is that while the Q1 earnings growth earlier on appeared to be on track to be low even by the modest standards of other recent quarters, it is slowly starting to look like those quarters in some respects. The improvement over the last few days is still not readily obvious from aggregate data, but it is there if look close enough. Hardly a ringing endorsement of the earnings picture, but nevertheless better than how the reporting season appeared headed just a few days back.
This modest positive aside, there is still plenty that is disappointing about the Q1 earnings. The most notable disappointing aspect of the Q1 earning season thus far is the lack of any improvement on the guidance front. Management guidance has been on the weak side for almost two years now, keeping the revisions trend firmly in the negative direction. We haven’t seen any improvement on the guidance front thus far, though it may be a bit premature to lose hope altogether.
The results thus far increase the odds that we wouldn’t see any change on that front this earnings season either. Estimates for Q2 have started coming down already and the pace of negative revisions will likely only accelerate as the rest of the reporting season unfolds. This will be consistent with a trend that has been in place for almost two years now; we know that the market made impressive strides in that time period.
The market has been a lot less forgiving lately, with the broad large-cap indexes barely up on the year. It will be interesting to see if investors will respond any differently to the coming period of negative estimate revisions.
Q1 Scorecard (as of April 24th, 2014)
Including this morning’s earnings announcements, we now have Q1 results from 204 S&P 500 members that combined account for 52.3% of the index’s total market capitalization. Total earnings for these 204 companies are up +2.9% from the same period last year on +3.6% higher revenues, with 68.3% beating EPS estimates and 44.0% coming out with positive revenue surprises.
Looking at the two sets of charts below – the first comparing total earnings growth for these 204 companies with what these same companies reported in 2013 Q4 and the 4-quarter average and the second comparing the beat ratios – it’s hard to see anything but all around weakness in the results thus far…
Q1 Growth Compared
Q1 Beat Ratios Compared
The EPS beat ratio is in in-line with recent quarterly averages, while the revenue beat ratio is materially weaker than what we have been seeing in recent quarters. What this means is that only 44.0% of the 204 companies that have reported results have beat revenue estimates, while 61.3% of the same group of companies beat top-line expectations in 2013 Q4 and the 4-quarter average for this group is 53.4%. Hard to call this performance anything but weak.
The primary reason for the sub-par aggregate growth rate is the drag from the Finance sector’s -8.4% earnings decline. We should keep in mind, however, that the Finance sector’s weak growth numbers are primarily due to Bank of America . Excluding the roughly $2 billion negative swing in Bank of America’s total earnings from the Finance sector, total earnings for the sector would be down only -1.6% and excluding Bank of America from the S&P 500 as whole would push up the aggregate growth rate to +4.8%.
Excluding the Finance sector as a whole, total earnings for the S&P 500 companies that have reported results would be up +6.9% on +4.8% higher revenues, which is actually better than what we have seen from the same group of ex-Finance companies in other recent quarters. This may not continue through the end of the earnings season, but it’s hard to overlook at this stage at least.
Total earnings for the 204 S&P 500 companies that have reported results are up 2.9%, with 67.3% beating earnings expectations. Revenues for these companies are up +3.5%, with a revenue ‘beat ratio’ of 44%.
The performance from these companies, particularly the earnings growth and revenue beat ratio, is weaker than what we have seen from this same group of companies in recent quarters.
The Finance sector shifted gear this quarter, becoming a drag on aggregate growth after being a growth driver for many quarters. Bank of America is a big reason for the sector’s weak growth this quarter, but the sector’s total earnings growth would be weak relative to other recent quarters even after excluding Bank of America from the numbers.
Excluding the Finance sector, total earnings for the rest of S&P 500 companies that have reported Q1 results would be up +6.9% on +4.8% higher revenues and modestly higher margins. This is actually broadly in-line with the growth performance we have been seeing from this ex-Finance cohort in recent quarters as well. Gilead’s strong results and its impact on the Medical sector has materially helped this ex-Finance growth picture.
Apple and Facebook had strong Q1 results, though overall results for the Technology sector are not materially better than what we had seen in the preceding quarter. Total earnings for the 66.1% of the sector’s total market capitalization that have reported results are up +8.3% on +4.9% higher revenues, with 66.7% of the companies beating EPS expectations and 59.3% beating revenue estimates.
The composite Q1 picture for the S&P 500, combining the actual results from the 204 companies with estimates for the 296 still to come, is for earnings to down -0.9% from the same period last year, on +2.2% higher revenues and 29 basis points in lower margins. Sequentially, total earnings for the S&P 500 are expected to be down -4.6%, with the overall level of total earnings for the index the lowest in a year.
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 are seeing the same trend in place with the Q1 reports as well. 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 +4.3%, followed by growth rates of +6.5% in Q3 and +9.0% in Q4. For the full year, total earnings are expected to be up +7.8% in 2014 and +12.2% in 2015.
The bottom-up ‘EPS’ estimate for the S&P 500 for 2014 currently stands at $115.54, while the top-down estimate for the same is currently at $116.33. For 2015, the bottom-up estimate remains $129.53, with the top-down estimate from Wall Street strategists currently at $125.
To see the full Earnings Trends report, please click here.