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Looking for Positives in the Q2 Earnings Season

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The following is an excerpt from this week's Earnings Trends piece. To access the full article, please click here.

We know that the picture emerging from the Q2 earnings season is one of overall weakness – growth is non-existent, with revenue gains particularly hard to come by and companies struggling to meet even the lowered top-line estimates. The outlook is no better for the current period either, with Q3 estimates following the by-now familiar downtrend that we have been seeing for the last many quarters.

Regular readers know that the tone and substance of our analysis of the earnings picture has been, and remains, on the negative side. That said, not everything on the earnings front is that bleak. Here are the three positives that stand out from the Q2 results thus far.

First, a number of sectors are able to generate growth despite the well-known growth challenges, with the Medical, Finance and Retail sectors standing out on this count among the major sectors. Plenty of Retail sector reports are still to come, but the sector’s top-line growth is tracking above what we have been seeing in other recent periods………………and it’s not solely because of Amazon’s (AMZN - Free Report) strong sales growth or easy comparisons at Walgreens (WBA - Free Report) . The growth rates at the Finance and Medical sectors are similarly broad based.

Second, the overall level of total earnings remains fairly high. Had it not been for the Energy sector drag, total Q2 earnings for the S&P 500 index would be in the vicinity of all-time records established in the recent past.

Third, estimates for the current period are no doubt coming down. But the magnitude of negative revisions for the current period is not as severe as we have become accustomed to seeing in other recent periods. Total earnings for the S&P 500 index are expected to be down -5.1% in Q3 from the same period last year, which is down from a decline of -2.7% at the end of June. This is a lower decline than we have seen in the comparable periods in other recent periods.

These positives may not be enough to change our overall view of the earnings picture, but they are nevertheless worth acknowledging.

Q2 Scorecard (as of August 12th, 2015)

Including this morning’s reports, we now have Q2 results from 455 S&P 500 members that combined account for 92.3% of the index’s total market capitalization. Total earnings for these 455 companies are down -2.6% on -4.1% lower revenues, with 70.0% beating EPS estimates and 49.6% coming ahead of top-line expectations.

For the small-cap Russell 2000 index, we have seen results from 1691 index members that combined account for 86.9% of the index’s total market capitalization. Total earnings for these 1691 Russell 2000 members are down from the same period last year -8.1% on +2.6% higher revenues, with 50.7% beating EPS estimates and only 35.7% beating sales estimates.

The chart below compares the growth rates and beat ratios for the 455 S&P 500 members that have reported results with other recent quarters.

As you can see in the right-hand side chart, earnings beats are tracking above historical levels while revenue beats are hard to come by. The revenue beat ratios remain below the 4-quarter average, but are above what we saw from this same group of companies in the preceding quarter (they were earlier tracking even below the prior-quarter’s very low levels). The left-hand side chart showing the growth comparison highlights the challenge on this front.

We know that Energy has been a big drag on the aggregate growth picture. Excluding the Energy sector, total earnings for the S&P 500 index would be up +5.1% on +1.3% higher revenues. But the growth comparison would still be unfavorable when we look at the results thus far on an ex-Energy basis, as the side by side charts below show.

As weak as the aggregate growth picture for the S&P 500 index is, the situation isn’t    that much different for the Small-cap Russell 2000 index. The chart below compares the growth rates and beat ratios for the 1691 Russell 2000 members that have reported results with what these same companies had reported in other recent quarters.

Looking at the earnings performance of the S&P 500 and Russell 2000 index at this stage, we see growth challenges in both places, with positive revenue surprises even more hard to come by in the small cap index. This runs counter to the conventional view of the small-cap players being better placed relative to the large-cap multinationals in the S&P 500 on account of their greater orientation to the domestic market.

To see the full Earnings Trends article, please click here.

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