The following is an excerpt from this week's Earnings Trends article. To see the full report, please click here.
Q1 Earnings Season in Final Stretch
We have reached the final stretch in the Q1 earnings season, with the Retail sector as the only one with any sizable number of reports still to come. As such, the broad trends established already are unlikely to change much. And those broad trends pertain to the anemic growth, lack of top-line surprises, and the persistently weak tone of management guidance that has been on display this earnings season.
None of this is surprising or new, as earnings growth has been hard to come by for some time and Q1’s unique issues only added to those pre-existing challenges. The shockingly weak GDP growth numbers for Q1, which appear on track to go down even more when revised in the coming day, spotlight the same issue(s). With respect to the economy, however, more recent economic data is pointing towards improved growth momentum from Q2 onwards, even though the pathway to the more aggressively optimistic GDP growth estimates is unclear at this stage.
We are not seeing anything comparable on the earnings front, with estimates for the current period starting to follow the trend that has been in place for almost two years now – they are going down. Five weeks into 2014 Q2, total earnings for the quarter are currently expected to be up +3.7% from the same period last year, a growth rate that is down from +5.5% about a month ago.
The chart below shows this evolution of 2014 Q2 estimates and compares this evolving negative trend with what we saw with the 2013 Q2 estimates over the comparable period (the orange bars represent 2014 Q2).
Earnings estimates are clearly coming down, but the chart above seems to suggest that the pace of negative revisions for the current quarter is lower than was the case in the comparable period in 2013. If that is the case, then it would be a net positive (or at least less negative).
To see whether we are seeing less negative revisions in the current quarter relative to other recent quarters, including 2013 Q2, take a look at the chart below.
This chart is showing the magnitude of total revisions for the first five weeks of 2014 Q2 and the comparable periods for each of the preceding 5 quarters, including 2013 Q2. What we mean by the magnitude of total revisions is that we took the estimate for total earnings for the S&P 500 at the beginning of each period (total earnings, not ‘mean’ or ‘median’ EPS) and compared that to the estimate for total earnings five weeks into each quarter. The numbers in the chart represent the change(s).
As you can see, the current estimate for total S&P 500 earnings in Q2 has dropped -2.2% in the first five weeks of the quarter, which is a lower drop than -3.0% drop in the comparable period in 2013 Q2. It is also below the -3.1% drop we saw in the comparable period in the preceding quarter. But aside from these two quarters, the magnitude of negative revisions thus far is greater than the other periods. The -2.2% drop thus far in 2014 Q2 estimates is roughly comparable to the average of the 5-quarter data shown in the chart above (the grey bar).
Bottom line, Q2 estimates are following the trend that has been in place for almost two years now, with the pace expected to accelerate further in the coming days.
Q1 Scorecard (as of May 8th, 2014)
We now have Q1 results from 446 S&P 500 members that combined account for 92.2% of the index’s total market capitalization. Total earnings for these 446 companies are up +1.6% from the same period last year on +0.6% revenues, with 68.8% beating EPS estimates and 49.7% coming out with positive revenue surprises.
The two sets of charts below – the first comparing total earnings growth for these 446 companies with what these same companies reported in 2013 Q4 and the 4-quarter average and the second comparing the beat ratios – compare the results thus far with other recent quarters.
Q1 Growth Compared
Q1 Beat Ratios Compared
The EPS beat ratio is tracking better relative to recent quarterly averages, likely reflecting the low levels to which estimates had fallen ahead of the start of the Q1 earnings season. But the revenue beat ratio is on the weak side relative what we have been seeing in recent quarters.
We should keep in mind, however, that the primary reason for the sub-par aggregate growth rate is the drag from the Finance sector. The Finance sector results didn’t have much growth this quarter after many quarters of strong momentum, but the sector’s results were notably dragged down by weak results from Bank of America (BAC - Analyst Report). Excluding Bank of America from the Finance sector, total earnings for the sector would be only -2.66% (vs. down -7.0% otherwise). And excluding Bank of America from the S&P 500 as whole would push up the aggregate growth rate to +2.6%.
Excluding the Finance sector as a whole, total earnings for the S&P 500 companies that have reported results would be up +4.0% on +3.3% higher revenues, which is actually better than what we have seen from the same group of ex-Finance companies in other recent quarters.
The Q1 earnings season has ended for half of the 16 Zacks sector. Total earnings for the 446 S&P 500 companies that have reported results are up 1.6%, with 68.8% beating earnings expectations. Revenues for these companies are up 0.6%, with a revenue ‘beat ratio’ of 49.7%.
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, with Finance as the major drag.
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. Finance sector stocks have underperformed the S&P 500 index in price action as well, with the average Finance sector stock up +2.5% year to date vs. +2.7% gain for the index as a whole.
Excluding the Finance sector, total earnings for the rest of S&P 500 companies that have reported Q1 results would be up +4.0% on +3.3% higher revenues and modestly higher margins. This is actually modestly better than the growth performance we have been seeing from this ex-Finance cohort in recent quarters as well. Gilead’s (GILD - Analyst Report) strong results and its impact on the Medical sector has materially helped this ex-Finance growth picture.
Apple (AAPL - Analyst Report) and Facebook (FB - Analyst Report) 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 88.0% of the sector’s total market capitalization that have reported results are up +4.9% on +4.2% higher revenues, with 73.1% of the companies beating EPS expectations and 59.6% beating revenue estimates.
The Utilities sector has been the best performer in the S&P 500 year to date in terms of stock price performance – up +13.3% vs. a gain of +2.7% for the index as whole. The sector has also been a strong performer on the earnings front in Q1, with total earnings for sector up +18.3% on +11.1% higher revenues and 72.7% of the companies beating EPS estimates and 75.8% coming ahead of revenue estimates.
The composite Q1 picture for the S&P 500, combining the actual results from the 446 companies with estimates for the 54 still to come, is for earnings to be up +1.2% from the same period last year, on +0.7% higher revenues on essentially flat margins. Sequentially, total earnings for the S&P 500 are expected to be down -3.6%, with the overall level of total earnings for the index the lowest in a year.
The consensus expectation is for the Q1 earnings season 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 Q1 reports as well. The recent negative announcement from J.P. Morgan (JPM - Analyst Report) about continued weakness in its capital markets business has started flowing through to estimates for other capital-markets heavy players like Bank of America (BAC - Analyst Report), Goldman Sachs (GS - Analyst Report) and others. The negative revisions trend will likely accelerate further as Retailers reports results in the coming days.
Total earnings in Q2 are currently expected to be up +3.7% (down from +5.5% in early April), followed by growth rates of +5.6% in Q3 and +9.2% in Q4. For the full year, total earnings are expected to be up +7.3% in 2014 and +11.2% in 2015.
The bottom-up ‘EPS’ estimate for the S&P 500 for 2014 currently stands at $116.65, while the top-down estimate for the year is currently at $117. For 2015, the bottom-up estimate remains $129.70, with the top-down estimate from Wall Street strategists currently at $125.
To see the full Earnings Trends article, please click here.