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Is the Earnings Improvement for Real?

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

We are off to a good start in the Q3 earnings season – earnings and revenue growth is tracking better relative to what we have seen the last few quarters and a bigger proportion of companies are coming out with positives surprises for both earnings as well as revenues. Improved results from the major banks are a big reason for the overall positive picture at this stage, but the aggregate picture is tracking below relative to other recent quarters even on an ex-Finance basis.

If this trend continues in the coming days, then aggregate Q3 earnings growth will move into positive territory, the first time after 5 back-to-back quarters of earnings declines for the S&P 500 index. Total Q3 earnings are currently expected to be down -1.0% from the same period last year on +1.5% higher revenues, a notable improvement from the -2.9% decline a few weeks back.

Importantly, estimates for the current period are holding up better relative to the comparable periods in other recent quarterly cycles. Total Q4 earnings are currently expected to be up +5.2%, only modestly down from last week’s +5.3% growth pace. The expectation is for an even more notable ramp up in growth over the following quarters, with full-year 2017 growth expected to be in double digits. Continuation of the positive Q3 reporting trend over the coming days will add to confidence in those expectations.

Q3 Scorecard (as of October 19th)

Including all of today’s earnings reports, we now have Q3 results from 81 S&P 500 members that combined account for 19.9% of the index’s total market capitalization. Total earnings for these 81 index members are up +3.8%% from the same period last year on +3.6% higher revenues, with 80.2% beating EPS estimates and 63% coming ahead of top-line expectations.

The side-by-side charts below compare the results thus far from the 81 index members with what this same group of index members reported in other recent periods. The left-hand chart compares the earnings and revenue growth rates with historical periods while the right-hand chart is doing the same comparisons for positive EPS and revenue surprises.

The takeaways from these comparison charts are:

First, earnings growth for these 81 index members is not only tracking better relative to what these same 81 companies reported in the preceding quarter, but also the 4- and 12-qurater averages. In other words, the earnings growth pace has notably improved relative to the recent past.

Second, the improvement in growth on the revenue side growth is even more notable, with Q3 revenue growth for these 81 index members notably better relative the preceding quarter as well as the 4- and 12-quarter averages.

Third, positive EPS surprises for this group of companies are tracking notably above historical periods. This could be interpreted to mean that estimates may have been too low ahead of the start of this reporting season. But the reality is that Q3 estimates didn’t fall as much as had been the case with other recent quarters.  

Fourth, positive revenue surprises are also notably tracking above historical levels. Given the earlier comment about the modest negative revisions to Q3 estimates ahead of the start of this earnings season, it is reasonable to interpret the revenue trends (both growth as well as surprises) as a sign of improvement in the overall earnings picture.

Given this, the answer to the question raised upfront is: Yes, the earnings picture is improving.

As mentioned earlier, Finance sector results really stand out at this stage. With results from 19 of the sector’s 90 members in the S&P 500 index already out, the sector’s Q3 earnings are up +4.6% on +4.7% higher revenues, with an impressive 89.5% beating EPS estimates and an equally impressive 78.9% coming ahead of top-line expectations. J.P. Morgan (JPM) started the Q3 outperformance for the space, which was dutifully continued by Citigroup (C), Bank of America (BAC), Goldman Sachs (GS - Free Report) and others.

For Q3 as a whole, combining the actual results from the 81 index members with estimates from the still-to-come 419 companies, total earnings are expected to be down -1 % from the same period last year on +1.5% higher revenues. The blended Q3 growth rate has started improving as companies come out with better than expected results (the growth rate was -2.9% last week).

Estimates Beyond Q3

The chart below shows Q3 growth expectations contrasted with what was actually achieved in the preceding four quarters and estimates for the following four periods. Full-year 2016 earnings growth expectations are in negative territory now, similar to what we saw the year before (both years are modestly positive on an ex-Energy basis).

The improvement in Q3 growth following the strong recent results indicated that we could very well end up modestly in positive territory for the quarter. But there is no question about expectations for Q4 and beyond, with positive growth is expected to resume in Q4 and ramp up in the following quarters. Earnings growth is expected to be in double-digits in 2017 and the following year.

Easier comparisons for the Energy sector arrive in Q4, when the sector’s earnings growth turns positive. But the expected growth in Q4 and beyond isn’t solely a function of easy comparisons for the Energy sector – the expectation is for positive momentum from a broad cross section of sectors. Those expectations will most likely need to come down. But it will be interesting to see to what extent they will have to come down.

Note: Sheraz Mian manages the Zacks equity research department. He is an acknowledged earnings expert whose commentaries and analyses appear on 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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