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Taking Stock of the Q3 Earnings Season

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

With results from more than half of the S&P 500 members already on the books, we have a good sense of how the Q3 earnings season has unfolded. The actual numbers will evolve over the coming days as more companies report results, but we have seen enough to say with plenty of confidence that growth remains non-existent, companies are struggling to beat lowered estimates particularly for revenues, and guidance remains on the negative side prompting estimates for the current period to come down at an accelerated pace.

The picture emerging from the Q3 earnings season is no doubt one of all-around weakness, but some pockets of strength are apparent as well. The Tech sector has been able to demonstrate earnings power from a number of major players like Apple (AAPL - Free Report) , Google parent Alphabet (GOOGL - Free Report) , and Microsoft (MSFT - Free Report) .  Other areas with good earnings momentum include the Telecoms and the airlines.

Q3 Scorecard for the S&P 500 (as of October 28th, 2015)

Including this morning’s reports, we now have Q3 results from 253 S&P 500 members that combined account for 61.9% of the index’s total market capitalization. Total earnings for these 253 companies are up +2.4% on -1.4% lower revenues, with 70.5% beating EPS estimates and only 42.9% coming ahead of top-line expectations.

The chart below compares the growth rates and beat ratios for these 253 companies with what this same group of companies reported in other recent quarters.

Any way you look at it, this is weak performance from these 253 index members relative to what we have seen from this same cohort in other recent periods. Please note that the earnings growth rate (+2.4%) is actually even lower once the easy comparisons at Bank of America (BAC - Free Report) are taken into account. The top-line weakness is particularly notable, both with respect to growth rate as well as beat ratios. The fact that revenue growth is this weak isn’t that surprising given the macro headwinds. But the fact that so few companies have been able to beat the lowered top-line estimates has been a big disappointment.

Looking at Q3 as a whole, combining the actual results from the 253 S&P 500 members with estimates for the still-to-come 247 index members, total earnings for the index are expected to be down -2.7% from the same period last year on -3.9% decline in revenues. This would follow the -2.1% decline in earnings on -5.7% lower revenues in the preceding quarter.

Q3 Scorecard for Russell 2000 (as of October 28, 2015)

Please note that the top-line weakness this earnings season isn’t restricted to multinationals in the large-cap S&P 500 index. The relative domestic oriented small-cap members of the Russell 2000 index aren’t doing any better either.

For the Russell 2000 index, we currently have Q3 results from 486 members that combined account for 29.1% of its total market cap. Total earnings for these 486 index members are down -3.6% from the same period last year on +0.3% higher revenues, with 50.6% beating EPS estimates and only 32.1% beating revenue estimates. This is weaker performance than we have seen from same group of 486 index members in other recent periods, as the charts below show.

2015 Q4 Estimates

Estimates for the current period are coming down at an accelerated pace, with total Q4 earnings for the S&P 500 index now expected to be down -6.6% from the same period last year, which is down from an expected decline of -4.7% two weeks back. The magnitude of negative revisions to Q4 earnings estimates is greater than what we saw in the comparable periods for the preceding two quarters.

The chart below shows current Zacks consensus earnings growth expectations for the coming 4 quarters as well as the same for 2015 Q3 (shaded orange) and the actual growth achieved in the first two quarters of the year. As you can see, this year’s growth has effectively evaporated, with growth momentum expected to pick up in 2016 Q2 and accelerate in the following quarters.

Part of the stronger looking growth in the second half of 2016 reflects an end to the Energy sector’s drag due to easier comparisons for that sector. But hopes remain high for actual growth as well, particularly from the Finance and some of the economically sensitive sectors. It is reasonable to be skeptical of next year’s optimistic looking expectations given how the 2015 estimates evaporated in front of our eyes over the last two quarters. May be it will be different this time. But judging from what we have heard from management teams on the Q3 earnings calls in recent days, it is more than reasonable not to buy into these estimates.

To read the full Earnings Trends article, please click here

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