Quick Market Update
Another Record Season for Earnings
November 1, 2013
Mark Litzerman, CFA®
Manager, Proprietary Equity Strategies and Research
In this Quick Market Update:
This quarter’s earnings remain modest yet steady
Earnings results so far this quarter have been encouraging with pleasant surprises to both the top and bottom line.
Positive earnings surprises are currently sitting at 69 percent.
Negative earnings surprises have declined from 25 percent to about 21 percent year over year.
We believe current earnings level supports $108 full-year earnings target.
Recent market earnings seasons have barely registered on the excitement scale for investors. Most likely, that’s because the market environment has featured rather boring low-to-mid single digit growth rates for earnings and only slightly positive growth rates for sales. The lead-up to the current quarter was, in fact, almost non-existent as the equity markets were mainly focused on the political dysfunction in Washington D.C. and the possibility of the U.S. becoming a “deadbeat” creditor. Not too many investors were considering how profitable companies were in the quarter, if the country was refusing to pay its bills!
With the debt-ceiling drama behind us for now, corporate earnings have taken center stage. Although the slow growth trend continues, the overall tone of the earnings results, thus far this quarter, has been encouraging with some pleasant surprises on both the top and bottom lines. Indeed, after quarterly earnings per share for the S&P 500 Index essentially flattened out in 2012, they are now poised to achieve a third-consecutive quarterly record, currently on track to hit $26.80.
Once again this quarter, positive earnings surprises have been strong, currently about 69 percent. In addition, compared to a year ago, negative surprises have declined, from 25 percent to about 21 percent. However, these surprise numbers should be taken with a grain of salt as lowering the expectations bar among analysts has become quite commonplace. Notwithstanding the lowered targets, a record is a record, and earnings this quarter continue to grow at a modest, yet steady, pace. In this Quick Market Update we review the current season’s earnings results and implications for investors.
Earlier in the year, there was widespread concern about companies facing challenges to growing revenues. In fact, in the second quarter, only four of 10 S&P 500 Index sectors showed positive growth. The primary concern, simply put, was that for earnings to continue to grow, sales would have to increase as there was little to no room for companies to expand their margins. What has thus far received little attention from investors this quarter is a noticeable increase in the overall sales growth numbers. With well over half of S&P 500 Index companies reporting, sales have increased about 3.7 percent year-over-year with eight of 10 sectors expected to report increases.
Chart 1: S&P 500 Sales Growth
Source: Bloomberg 10/31/13
An overlooked silver lining
There is an additional silver lining in the revenue numbers that is not so readily apparent. The underlying performance of most S&P 500 Index sectors has been more positive than the top line numbers reveal. Typically, aggregate S&P 500 Index earnings and sales results are shown “ex-financials.” This is because earnings from the Financial Services sector are excluded on the presumption that the “non-financials” sectors provide a more accurate reading of the earnings environment for companies that produce physical products. For the current quarter, the expected revenue growth is slightly lower when Financials are included in the estimates. This is not surprising given the struggle that many banks are having growing revenues in the current low-interest-rate environment.
Chart 2: S&P 500 Energy Sector vs. WTI Oil (Price to Sales Relationship)
Source: Bloomberg. 10/31/13
Meanwhile Energy is having a negative effect on overall revenue growth for the quarter. As Chart 2 above shows, energy prices, specifically oil and natural gas, tend to have a high correlation with revenues for energy companies, because, they are dominated by the largest multinational integrated oil companies. Historically, in the absence of geo-political disruptions, higher energy prices are often closely tied to economic growth, as demand grows more quickly than supply. However, global economic growth has moderated and the supply of energy reserves has increased as a direct result of significantly increased production in the U.S. As a result, global oil prices have stabilized and natural gas prices have declined by over 50 percent since 2009. Due to the shift in supply and demand, estimated earnings for the sector are over 18 percent below those of the third quarter of 2011. More significantly, based on the current full-year consensus estimate, if the Energy sector is excluded, the growth rate for year-over-year S&P 500 Index revenues for 2013 nearly doubles from 1.7 percent to 3.3 percent. It appears that weakness in the Energy sector may be masking more positive underlying trends in overall earnings growth.
Indeed, we have observed good results and improving outlooks across a broad base of companies that have reported earnings this quarter. Materials companies have reported better-than-expected volumes. Industrials have had improved results on an increase in demand and improved pricing for rails and airlines. Higher drug volumes aided a number of large pharmaceutical companies. And, technology companies have had a much better tone to their results, including better-than-expected results from several of the largest companies.
Overall, there are many more positive attributes in this quarter’s earnings results than negative. While overall economic conditions remain sluggish, momentum appears to be heading in the right direction. The consensus estimate for the fourth quarter, which was likely overstated, has been revised downward. This reflects, at least in part, a temporary impact on certain companies due to the government shutdown. Looking ahead, the preliminary consensus estimate for 2014 has edged down only slightly. As we transition into the holiday season, a rebound in consumer sentiment will be a key variable driving analyst revisions for a number of key sectors, including consumer discretionary and consumer staples. However, we do not see any major impediments to the earnings trends that we have been observing this quarter. We believe current quarter earnings continue to support our $108 full-year earnings target.
All data for this Quick Market Update was sourced from Bloomberg Finance, LLP, unless otherwise noted.
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