Earnings Roundup: Negative Guidance Trend Continues

Though guidance among S&P 500 companies appears ominous as fourth quarter earnings season begins, with the Information Technology sector showing continuing signs of trouble, Consumer Discretionary looks positive, and some companies may end up beating lowered estimates. 

As the first companies begin to report fourth quarter earnings results, the guidance trend continues to show ominous signs. So far, S&P 500 companies have issued negative guidance 97 times and positive guidance only 27 times. This results in a ratio of 3.6 negative preannouncements for each positive one. This follows the similarly negative guidance sentiment that we saw in the third quarter. Earnings estimates have fallen as company management teams have warned about their earnings. Currently, analysts expect that fourth quarter earnings will grow 3.0% over the fourth quarter of last year. While this growth estimate is a slight improvement over the 0.1% growth in the third quarter, it is far lower than the 9.9% growth forecast at the beginning of the fourth quarter in October.

Guidance varies significantly across sectors, as seen below in Exhibit 1. With around a quarter of the companies in the S&P 500 providing earnings guidance, the view is mostly negative. In a typical quarter, there are 2.3 negative preannouncements for each positive one. With the exceptions of Telecommunications Services and Utilities, which have few companies issuing guidance, Consumer Discretionary is the only sector to have above-average guidance sentiment.

Guidance within the Information Technology sector is continuing a downward trend that began earlier this year. The negativity in earnings guidance has accompanied a drop in earnings growth, as seen below in Exhibit 2. With 6.0 negative preannouncements for each positive one, the sector has gone from a source of strength for the index to a source of weakness. Coming on top of a strong fourth quarter of 2011, where companies in the sector grew earnings by 16.8%, analysts estimate that earnings will shrink by 1.1% in the fourth quarter of 2012.

The Information Technology sector had previously held up well as business spending on technology allowed customers to reduce expenses and increase efficiency. This helped companies to maintain margins in this environment of slow revenue growth, but it appears that technology investments are being targeted by companies continuing to cut costs. Adding to the pain is the sector’s heavy presence in Asia, where growth is slowing and hurting profits for American companies operating there, as discussed in last week’s report. The magnitude of the guidance is striking as well. The preannouncements are not just slightly below analyst estimates, as they are in other sectors – the average preannouncement in tech is 12.5% below estimates at the time the guidance was issued, and some are more than 50% below.

Within all the negative guidance, there is some good news to be found. Consumers, who can often be counted on to spend even when businesses have decided not to, are expected to power fourth quarter results. Analysts estimate that the Consumer Discretionary sector will grow earnings by 11.5% in the fourth quarter, which would be the second highest growth rate after Financials. Management teams within Consumer Discretionary have been bullish on their earnings prospects as well, with 1.8 negative preannouncements for each positive one. With the average preannouncement in the sector coming in at 4.8% below analyst estimates at the time, it is not seeing as many surprisingly large negative preannouncements as many other sectors.

In recent quarters, negative guidance has led to lower earnings estimates in the run-up to earnings season, only to have companies beat these lowered estimates. There is a possibility that this will occur again as companies report for the fourth quarter. However, as the sectors that drove profit growth in previous quarters begin to falter, others will need to show improvement for earnings overall to continue their positive growth streak.