Strong Tech Results Reflect a Resilient Earnings Picture

Sheraz Mian Published on July 26, 2023

Note: The following is an excerpt from this week’s Earnings Trends report. You can access the full report that contains detailed historical actual and estimates for the current and following periods, please click here>>>

Here are the key points:

The picture emerging from the Q2 earnings season is one of continued resilience and strength, with an above-average proportion of companies not only beating estimates but also providing reassuring guidance for the coming periods.

There continues to be modest pressure on estimates for Q3 and beyond, but a big part of that is coming from the Energy sector.

Importantly, the evolving earnings outlook for the coming periods is inconsistent with the long-feared ‘earnings cliff’ narrative.

For the 151 S&P 500 companies that have reported Q2 results, total earnings are up +3.1% from the same period last year on +6.9% higher revenues, with 81.5% beating EPS estimates and 63.6% beating revenue estimates.

In other words, 2023 Q2 is expected to be the third consecutive quarter of declining S&P 500 earnings. The expectation currently is for another earnings decline in Q3 of -2.4%, after which growth turns positive in Q4 and continues in 2024. In fact, Q3 earnings would be positive had it not been for the Energy sector drag.

As you can see from these quarterly earnings-growth expectations, the long-feared recession doesn’t show up in this near-term earnings outlook. A big-picture view of corporate profitability on a long-term basis doesn’t leave much room for a recession either, as you can see in the chart below.

These growth expectations reflect current bottom-up consensus earnings estimates for the individual S&P 500 companies that, in turn, are based on the estimates from individual sell-side analysts that cover those companies.

Predicting recessions is beyond the core competence of equity research analysts. But they do keep a close eye on the evolving business trends for the companies and industries they follow. Analysts maintain elaborate financial models for the companies in their coverage, which allows them to come up with their earnings, revenues, and other estimates.

We at Zacks make it our business to closely monitor how analysts’ earnings estimates evolve over time. In fact, our rating system, the Zacks Rank, is based on earnings estimate revisions.

Regular readers of our earnings commentary know that we have flagged a notable stabilization in the estimate revisions trend since the start of 2023 Q2, reversing the persistently negative trend that had been in place for almost a year prior.

Earnings estimates in the aggregate for the S&P 500 index have come down only a touch since the start of April, with a number of key sectors starting to see modest positive estimate revisions. These sectors include Construction, Industrial Products, Autos, Tech, Medical, and Retail.

Hard to tell at this stage if the revisions trend will remain on its recent positive trajectory or revert back to its original negative trend. But it is nevertheless a market-friendly development.

Sector Focus

The strong Microsoft (MSFT - Free Report) and Alphabet (GOOGL - Free Report) reports go some ways towards reassuring investors of opportunities in the artificial intelligence space while showing clear signs of stabilization, if not altogether improvement, in their core businesses.

Alphabet’s better-than-expected Q2 earnings and revenues represented year-over-year growth rates of +14.8% and +8%, respectively. The company’s results show reacceleration in search and clear signs of stabilization in advertising spending, with the latter also providing a favorable read-through for Meta (META - Free Report) and other ad-driven digital players.

Microsoft’s top- and bottom-line beats represented year-over-year earnings and revenue growth rates of +20% and +8.3%, respectively. Guidance suggested strong demand for its AI services, as the raised Azure revenue guidance shows. Microsoft also indicated accelerating its cloud investments, with capex sequentially increasing each of the next four quarters. This likely provides a favorable read-through for Nvidia (NVDA - Free Report) and other chipmakers.

Microsoft, Alphabet, Meta, and Nvidia are part of what we call the ‘Big 7 Tech Players’, with Apple, Tesla, and Amazon as the remaining club members. These mega-cap players have led the market’s surge this year, though the rally has recently expanded beyond these seven stocks.

For the ‘Big 7 Tech Players’ as a whole, Q2 earnings are expected to be up +19.1% from the same period last year on +8.7% higher revenues, as the chart below shows.

The chart below shows the group’s earnings picture on an annual basis.

Q2 earnings for the Tech sector as a whole are expected to be down -1.4% from the same period last year on +0.3% higher revenues. Estimates have inched up since the period got underway, largely reflecting more effective cost controls. But the aforementioned signs of stabilization in Microsoft and Alphabet’s core businesses will go some ways towards improving the revenue outlook for the group.

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