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Long Story Short: Trade issues and a weak global economy aren’t hurting earnings yet
Are Strong Earnings a Sign that Economic Concerns are Unwarranted?
(Note: companies that could be impacted by the content of this article are listed at the base of the story [desktop version]. This article uses third-party references to provide a bullish, bearish, and balanced point of view; sources are listed after the Balanced section.)
With 70% of the companies in the S&P 500 having reported September-quarter earnings, an impressive 76% have reported results above expectations as announced by Factset. This is above historical averages. In aggregate, results have been 3.8% above the consensus estimate. Nevertheless, concerns remain. Are the quarter’s results a sign that things are better than expected (Bull Case) or are there enough cracks to point out growing economic and political concern (Bear Case)?
The percent reporting positive surprises is higher than normal. It is not unusual for more companies to report positive earnings surprises than earnings disappointments. Historically, about 65% of the companies report results above expectations. Over the last four quarters, 74% of the companies have reported positive earnings surprises. So far, the third quarter is surpassing past results.
Stronger-than-expected results are a sign that management and analysts were being overly cautious. This year has been a year of great uncertainty from issues surrounding trade wars to Brexit to Federal Reserve tightening. Many management teams took a cautious stance regarding guidance because of the uncertainty. As the year unfolds without a significant negative impact on corporate results, the high level of positive earnings surprise is a sign that management and analysts were overly cautious.
The right industries are reporting strong results. It is worth noting that the financial sector is reporting strong results and that bodes well for the overall economy. Manufacturing has also been strong while the service sector has lagged other sectors, perhaps an initial sign of growing wage inflation. The energy sector is also expected to be weak given lower energy prices.
Results may be an upside surprise, but they are down year over year. For the companies reported, earnings are down 2.7% versus last year, on average. If this decline holds after all companies have reported, it will represent the third consecutive quarter of year over year declines.
Revenue surprises are not keeping up with earnings surprises. 80% of companies reported a positive earnings surprise, but only 64% reported a positive revenue surprise. Profit margins were stable at 11.3%. The positive earnings surprise relative to revenue surprise is an indication that companies were doing a better-than-expected job holding the line on costs. It may also reflect that fact that companies have been actively repurchasing shares. However, it may also reflect lower earnings quality as companies are taking accounting steps to grow earnings.
Estimates are being revised down more than up. Through October 18, 53% of estimate revisions lowered estimates while 47% increased estimates. Thus, even though third quarter results are coming in above expectations, management and analysts remain concerned about upcoming results.
It is probably too early in the earnings season to make any grand conclusions about this quarter’s results. We will know more after next week when 156 companies in the S&P report results. That said, initial results are encouraging and seem to indicate that management and analysts have overestimated the individual company impact of broader economic and political concerns.
https://insight.factset.com/sp-500-earnings-season-update-november-1-2019, John Butters, FactSet, November 1, 209
https://www.forbes.com/sites/jjkinahan/2019/10/21/earnings-extravaganza-this-week-brings-nearly-25-of-sp-500-company-reports/#51e809173f2d, JJ Kinahan, Forbes, October 21, 2019.
https://lipperalpha.refinitiv.com/2019/10/this-week-in-earnings-9/, David Aurelio, Refinitiv, October 18, 2019.