The following is an excerpt from this week's Earnings Trends article. To see the full article, please click here.
It’s All About Q3 Guidance
Earnings headlines will be the primary catalyst for stocks in the coming days as the Q2 earnings season takes center stage. We have only a handful of companies reporting this week, but the cycle really ramps up next week when more than 60 S&P 500 members coming out with Q2 results.
The chart below shows weekly schedule for how Q2 results will come out.
The earnings growth expected in Q2 represents an improvement over what we got in the preceding quarter. But that’s not really saying much give how weak Q1 was. Total Q2 earnings for companies in the S&P 500 are expected to be up +3% on +1% higher revenues and a modest uptick in net margins. Estimates fell as the quarter unfolded, a trend that we has been in place quarter after quarter for almost two years now, with the current +3% earnings growth down from +5.5% at the start of the quarter.
The magnitude of negative revisions in Q2, however, was relatively on the lower side relative to other recent quarters, likely indicating the analyst community’s improving growth outlook. Lower negative revisions to Q2 estimates could be interpreted to mean that estimates not ‘low enough’ for companies to easily beat. But given management teams’ well-earned reputation for anchoring analysts’ expectations, this seems like a low-probability event.
The more likely scenario is that we will see a repeat performance, with roughly two-thirds of the companies beating earnings estimates. But more important than beat ratios, the element of interest for the market will be how estimates for Q3 and beyond evolve in the coming days and weeks. As you can see in the chart below, consensus expectations reflect a material ramp up in the growth trajectory in the coming quarters.
Guidance has been overwhelmingly weak for quite some time, keeping the revisions trend firmly in the negative direction. Any improvement on that front will be a notable positive in the earnings picture and will validate the market’s gains thus far. On the other hand, it will be hard for the market to hold its ground in the face of continued negative guidance and revisions trends.
The 2014 Q2 earnings season has gotten underway. Alcoa (AA - Analyst Report) came out in style in its quarterly report, but it was preceded by 22 S&P 500 members with May fiscal quarters. Alcoa’s reassuring report notwithstanding, it is way too early to read anything into the results thus far.
Total earnings in Q2 are expected to be up +3.0% on +1.0% lower revenues and modest gains on the margins front. As has been the case quarter after quarter for almost two years, estimates for Q2 fell as the quarter unfolded. That said, the growth rate expected in Q2 represents an improvement over what was expected in the prior quarter at a comparable stage.
Three sectors – Utilities, Construction and Business Services – are expected to show double-digit growth rates in Q2. The Finance sector is expected to see another quarter of earnings decline, with total earnings for the sector expected to be down -3.6% from the same period last year. This would follow -7.1% decline in the sector’s earnings in Q1. But while the sector’s Q1 weakness was mostly due to Bank of America (BAC - Analyst Report), the Q2 weakness is broad-based.
Total earnings for the Utilities sector, the strongest price performer in the S&P 500 year to date, are expected to be up +11.3% after the +18.1% gain in Q1. The sector was a beneficiary of the frigid weather in Q1, the Q2 growth pace is a bit misleading as it primarily reflects easy comparisons for Verizon (VZ - Analyst Report), which we place in the sector.
Total earnings for the Technology sector are expected to be up +6.4% from the period last year on +4.7% higher revenues. This would follow +3.3% earnings growth for the sector on +2.7% higher revenues in Q1.
Beyond Q2, earnings growth for the S&P 500 is expected to accelerate to +5.6% in Q3 and +8.9% in Q4, with growth in the second half of the year ramping up to +7.3% from the first half’s +1.9% pace. Total earnings are expected to be up +7.2% in 2014 and +11.7% in 2015.
To see the full Earnings Trends report, please click here.