The following is an excerpt from this week's Earnings Trends article. To read the entire article, click here.
The Q2 earnings season has gotten off to a relatively soft start. But it appears that expectations have come down enough that investors are able to find some reassuring aspects to otherwise underwhelming reports.
Granted, this bearish-sounding verdict may be premature since we are at such an early stage in the reporting cycle and the sample of reports is so much weighted towards the Finance sector. But with results from roughly a tenth of the S&P 500 members that combined account for roughly one-fifth of the index’s total market capitalization already out, the sample size may not be that unrepresentative either.
Including this morning’s earnings reports, we now have Q2 results from 49 S&P 500 members that combined account for 18.7% of the index’s total market capitalization. Total earnings for these 49 companies are up +6.3% on +2.2% higher revenues, with 75.5% beating EPS estimates and 34.7% coming ahead of top-line expectations.
In terms of growth rates and beat ratios, the earnings performance is better than the 4-quarter average for this same group of companies, though earnings growth is tracking below what we saw in the preceding quarter. The emerging picture on the revenue picture is even weaker than what we saw in Q1, which itself was quite weak on the revenues front.
The chart below compares the growth rates and beat ratios for these 49 companies with other recent quarters.
As you can see in this chart, the revenue weakness isn’t just on the growth side, but really stands out on the surprises front. This is disconcerting given the low levels to which estimates had come down ahead of the start of this earnings season, which had raised hopes of more numerous positive top-line surprises relative to Q1. But we are not seeing that – at least not yet.
The relatively favorable comparison on the earnings growth front is thanks to good results from the large banks, whose results are heavily represented in the current sample. There is not much growth, even on the earnings side once the Finance sector numbers are excluded from the current sample of Q2 reports, as the side by side chart below shows.
Are Banks Really Doing Better?
Yes, they are. The results thus far are concentrated in the big banks and brokers, who seem to be putting the period of large litigation charges behind them – Citi (C - Analyst Report) , J.P. Morgan (JPM - Analyst Report) and Bank of America (BAC - Analyst Report) all had smaller expenses on that front, though Goldman Sachs (GS - Analyst Report) took a big charge this time around. This factor alone is the biggest contributor to bottom line growth for the sector thus far.
Total earnings for the 39.4% of the Finance sector’s market cap in the S&P 500 that has reported results are up +12.2% on -0.5% lower revenues, with 83.3% beating EPS estimates and only 25% coming ahead of revenue estimates. In terms of beat ratios, this is better performance than we had seen from this same group of banks in Q1 (yes, even the measly 25% revenue beat ratio is above the 16.7% we saw from this same group). While the revenue picture is as bad now as it has been other recent periods, the sector’s Q2 earnings growth pace compares favorably to other recent periods, particularly when adjusted for the outsized one-time benefit for Bank of America in the preceding period.
Crediting all of the sector’s improvements on the litigation expense tailwind will be unfair, as there is some improvement, howsoever modest, in core profitability.
Underlying loan demand is improving, as is the outlook for investment banking, with momentum on the advisory side of the business helping offset weakness on the fixed income trading side. These modest improvements in business coupled with tight cost controls should keep bank profits in the positive column in an otherwise very unhelpful interest rate backdrop.
The Blended Q2 Picture
Combining the actual results from the 49 S&P 500 members with estimates for the still-to-come 451 companies, total Q2 earnings for the index are expected to be down -4.7% on -5.1% lower revenues. Stronger results from the big banks has improved this growth picture, with the Q2 growth picture deteriorating to an earnings decline of -8.4% on -5.5% lower revenues on ax-Finance basis.
As you can see in the chart below, not much is expected in the second half of the year either.
But growth is expected to resume next year, with total earnings for the S&P 500 index expected to be up in the low double digits. But then again, expectations for outer periods always tend to be on the optimistic side.
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