by Tajinder Dhillon.
In 2021, we expect to see a year of high expectations for earnings growth as we exit 2020, which saw growth rates plummet during the first three quarters to levels not seen since the 2008 crisis. The earnings growth forecast for 2021 is currently 25.9%, the highest since 2010.
In a typical quarter, year-over-year (YoY) growth expectations decline by an average of 3.5 percentage points (ppts) from the start of the quarter to the start of earnings season. Seeing an increase in growth expectations heading into earnings season is fairly uncommon, but we have seen exactly this behavior for the third consecutive quarter. It is worth paying attention when it happens because it can be a signal of things to come as the quarter plays out.
20Q3 and 20Q4 earnings growth improved 1.7 and 1.5 ppts respectively from the start of the quarter to the start of earnings season. By the end of the earnings season quarter, we saw earnings growth improve by 15.0 and 14.1 ppts respectively. These increases were some of the largest on record since Refinitiv has tracked this data.
We mention this as 21Q1 has seen an even larger improvement in earnings growth from the start of the quarter to the start of earnings season. 21Q1 earnings growth has improved from 19.8% to 24.2% over this period, resulting in a 4.4 percentage point increase. As shown in Exhibit 1, this is the largest gain since 2010Q2 and the fifth largest gain since 2002.
Exhibit 1: S&P 500 Growth Rate Change Heading into Earnings Season
This raises the question as to whether we will see similar improvements in the 21Q1 earnings growth when the dust settles. To help frame perspective around this, we can look at the earnings surprise factor. Over the past four quarters (20Q1-20Q4), the average earnings surprise factor has been 15.2%, well above the long-term surprise factor (since 1994) of 3.7%.
If we assume this trend will continue in 21Q1 and apply the prior four quarter average surprise factor of 15.2% to the companies yet to report, we could potentially see 21Q1 earnings growth improve to 42.4% by the end of earnings season.
This may be a stretch given that the current 21Q1 earnings surprise factor is 7.0% for the 16 constituents that have already reported results. If we apply a more conservative surprise factor of 7.0%, 21Q1 earnings growth could improve to 32.6% by the end of earnings season.
21Q1 earnings growth expectations have steadily increased over the last five months as shown in Exhibit 2. The expected 21Q1 earnings growth rate is currently 24.2%, which has increased from 16.0% at the beginning of the year.
Exhibit 2: S&P 500 21Q1 Earnings Growth Trend
YoY comparisons may not be as meaningful this year given the low base from 2020. Instead, we look at the rate of change in growth rate expectations as a better indicator of sentiment.
All but two sectors have seen positive revisions to 21Q1 growth expectations since the beginning of the year. The rotation into value seems to be at the forefront, as the Energy sector has seen the largest upward revisions in growth expectations since the beginning of the year, improving 51.2 percentage points (-5.1% vs. -56.3%). The Financials sector has seen the second largest increase in growth expectations this quarter, improving 20.2 ppts (68.9% vs. 48.7%). Finally, the Materials sector has seen the third largest increase in growth expectations, improving 16.7 ppts (47.0% vs. 30.3%).
Only Consumer Staples and Industrials have seen negative revisions to earnings growth during this period. The Industrials 21Q1 earnings growth rate has declined from -0.1% to -13.4%, while the Consumer Staples growth rate has declined from 1.0% to 0.3%.
Banks traditionally kick off earnings season and are looking to continue the strong momentum from 20Q4. Looking at the latest This Week in Earnings report, four of the ‘Big Six’ banks including Goldman Sachs, Morgan Stanley, JPMorgan Chase, and Citigroup are expected to post a positive earnings surprise, using StarMine Analytics.
Exhibit 3: Banks’ Positive Surprise
Goldman Sachs has the largest Predicted Surprise (PS) of 16.2% followed by Citigroup at 11.9%. The PS compares the StarMine SmartEstimate to the consensus mean. By overweighting analysts who are more accurate and timelier, the SmartEstimate provides a refined view into consensus. Comparing the SmartEstimate to the mean estimate leads to our PS, which accurately predicts the direction of earnings surprise 70% of the time.
In addition to a positive PS, the banks in Exhibit 3 also have a very high ARM Region Rank score. ARM stands for the Analyst Revision Model, which looks at analyst estimate revisions across Revenue, EBITDA, and EPS over the current quarter, current year, and upcoming year, while also incorporating changes in recommendations. A high model score indicates positive analyst sentiment while also being indicative of future analyst revisions.
Four new constituents were added to the S&P 500 effective March 22. These include NXP Semiconductors NV (NXPI.OQ), Generac Holdings (GNRC.N), and casino-based Caesars Entertainment Inc. (CZR.OQ) and Penn National Gaming Inc (PENN.OQ).
Penn National and Caesars Entertainment have seen share prices rise remarkably by 960% and 661% respectively over the last year. Both companies make their first appearance in the index and joins MGM Resorts International (MGM.N), Wynn Resorts Ltd. (WYNN.OQ), and Las Vegas Sands Corp. (LVS.N) in the S&P 500 Casinos & Gaming sub-industry.
The Casinos & Gaming sub-industry is expected to post 21Q1 earnings growth of only 0.2%, which is weighed down by MGM’s expected earnings growth of -151.4%. However, new entrant Penn National Gaming is expected to post the largest earnings growth in the sub-industry of 105.1%. Penn National is also currently expected to post the largest earnings growth in 21Q2 at 121.7%.
On a full-year basis, 2021 earnings growth for the sub-industry is expected to grow 77.3%, while revenues are expected to grow 88.3%.
On a FY3 basis, Penn National trades at a P/E of 25.6x and a Net Debt/EBITDA ratio of 2.1x. In comparison, Caesars Entertainment trades on a 43.2x and 4.1x basis respectively. Interest coverage is stronger for Penn National as it trades at a FY3 basis of 2.4x, in comparison to 1.0x for Caesars Entertainment.
However, looking at FY1-FY3 growth, Caesars Entertainment has the edge over Penn National with a 9.7% compound annualized growth rate (CAGR), compared to 7.4% for Penn. EBITDA CAGR is 17.1% for Caesars in comparison to 7.7% for Penn.
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