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A Critical Look at the Q1 Earnings Season

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Note: The following is an excerpt from this week’sEarnings 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:

•    Growth is very strong in Q1, but that was no surprise for the market. Importantly, the growth picture for the current and coming quarters is effectively the same as before the start of this earnings season.
 
•    Total Q1 earnings for the 444 S&P 500 companies that have reported results already are up +24.5% from the same period last year on +9.3% higher revenues, with 77.7% beating EPS estimates and 75% beating revenue estimates.
 
•    Except for the proportion of these 444 index members beating EPS and revenue estimates, which are tracking roughly in-line with the preceding quarter’s level, growth in Q1 is notably tracking above historical periods.

•    The Retail sector is the only one that has a sizable number of reports still to come. The earnings season has ended for 7 of the 16 sectors in the S&P 500, including Finance, and most of the other sectors in the index are close to the finish line.

•    Looking at Q1 as a whole, total earnings are expected to be up +23.6% from the same period last year on +8.8% higher revenues, the highest quarterly earnings growth pace in 7 years.
 
•    Earnings growth is expected to be in double-digit territory from the year-earlier level for 13 of the 16 Zacks sectors, including the Technology and Finance sectors. The Auto sector has the weakest growth of all 16 sectors, with +0.3% earnings growth on +1.4% higher revenues.

•    Net margins are expected to increase 1.4 percentage points from the year-earlier period, with Finance, Technology, Industrials, Energy, and Construction driving most of the margin gains.

•    Energy sector earnings are expected to be up +76% from the same period last year on +14.4% higher revenues. Excluding the Energy sector, total S&P 500 earnings growth drops from +23.6% to +21.9%.

•    For the small-cap S&P 600 index, we now have Q1 results 83.4% of the index’s total membership. Total earnings for these companies are up +23.8% on +10.3% higher revenues, with 64.7% beating EPS estimates and 72.5% beating revenue estimates. In addition to earnings and revenue growth, revenue surprises are notably tracking above historical periods for the small caps.

•    For the quarter as whole, total S&P 600 earnings are expected to be up +17.1% on +9.1% higher revenues. We have more details about small-cap data on page 29 of the full report.

•    For full-year 2018, total earnings for the S&P 500 index are expected to be up +19.2% on +5.7% higher revenues. For full-year 2019, earnings are expected to be up +9.4% on +4.5% higher revenues.

•    The implied ‘EPS’ for the index, calculated using current 2018 P/E of 17.2X and index close, as of May 8th , is $155.66. Using the same methodology, the index ‘EPS’ works out to $170.26 for 2019 (P/E of 15.7X). The multiples for 2018 and 2019 have been calculated using the index’s total market cap and aggregate bottom-up earnings for each year.   

The earnings and revenue growth rate in the Q1 earnings season has been very strong. But a lot of that strength was already expected following the very strong earnings season at the start of this year that coincided with all-around positive estimate revisions in the wake of the tax-cut legislation. The fact is that the earnings picture had been steadily improving since the second half of 2017 and in some respects the 2017 Q4 earnings season was actually a lot stronger than what we saw companies report this earnings season.

There has not been any incremental improvement in the earnings outlook relative to what was expected ahead of the start of this earnings season. We see this in the underwhelming revisions trend for the 2018 Q2 quarter, which is in contrast to the very positive revisions trend we saw ahead of the start of the Q4 earnings season.

There has been almost no change to aggregate 2018 Q2 estimates as the chart below shows.

A big part of the positive revisions we saw ahead of the start of the Q1 earnings season reflected the direct impact of the tax law changes, which was obviously a one-off development. Had all positive revisions been a result of tax law changes, we would have seen only EPS estimates go up, with no changes to revenue estimates. But that wasn’t the case, as revenue estimates had gone up as well, which raised our hopes that the aggregate revisions trend had finally turned positive after many years being in the other direction.

Disappointingly, we are not seeing that with estimates for Q2, as the above chart shows. In other words, the growth picture coming out of this earnings season is very impressive, but there is no improvement in expectations for the current and coming quarters. The recent uptrend in the exchange value of the U.S. dollar and questions about global growth will likely serve as incremental negatives for folks like us monitoring the aggregate revisions trend.

This flat aggregate revisions trend notwithstanding, June quarter estimates have actually modestly ticked down for 11 of the 16 Zacks sectors and gone up for 4 sectors. The sectors enjoying positive revisions in the aggregate include Technology, Industrial Products, Basic Materials and Retail.

Amazon (AMZN - Free Report) is a big contributor to the +5.9% upward revision to the Retail sector’s June-quarter aggregate earnings expectations, as the online giant’s estimates for the quarter have jumped almost +67% since the company’s April 26th quarterly release. Estimates for traditional retailers like Wal-Mart (WMT - Free Report) , Target (TGT - Free Report) , Macy’s (M - Free Report) and others that will be reporting March-quarter results in the coming days haven’t moved much.   

Expectations Beyond Q1

The chart below contrasts the Q1 earnings growth rate with what was actually achieved in the last 5 quarters and what is expected in the coming three periods.

As discussed earlier, estimates for the current period (2018 Q2) haven’t moved much since the Q1 earnings season got underway. This is in contrast to what we had seen ahead of the start of the Q1 earnings season when estimates had gone up in a big way. The fact that we aren’t seeing any positive revisions to Q2 estimates is therefore disappointing for an otherwise very strong earnings season.

Note: Sheraz Mian manages the Zacks equity research department. He is an acknowledged earnings expert whose commentaries and analyses appear on Zacks.com and in the print and electronic media. His weekly earnings related articles include Earnings Trends and Earnings Preview. He manages the Zacks Top 10 and Focus List portfolios and writes the Weekly Market Analysis article for Zacks Premium subscribers.

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