June 24, 2021

S&P 500 21Q2 Earnings Preview: Value Leading the Way

by Tajinder Dhillon.

21Q2 preferred earnings year-over-year (YoY) growth is currently forecasted at 64.0% (as of April 18th), which is the highest since 2009 Q4.  This quarter will likely result in ‘peak’ earnings growth in absolute terms, as 21Q3 earnings growth is forecasted to be 24.2%, while 21Q4 and 22Q1 is currently expected to be 16.8% and 2.5% respectively.

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 uncommon, but we have seen exactly this behavior for the fourth consecutive quarter.  The last time we have seen four consecutive quarters of improved growth expectations heading into earnings season was in 2004.

Off the back of a monumental 21Q1 earnings season, earnings growth expectations in 21Q2 has improved from 60.0% to 64.0% from the start of the quarter to the start of earnings season, resulting in a 4.0 percentage point (ppt) increase.  As shown in Exhibit 1, this is the 2nd largest gain since 2010 and the 6th largest gain since 2002.

Exhibit 1: S&P 500 Growth Rate Change Heading into Earnings Season

How high can we go?

21Q1 saw the largest intra-quarter improvement of earnings growth from the start of earnings season to the end of earnings season (24.2% –> 52.8%) since Refinitiv has tracked this data.  This raises the question as to whether we will see similar improvements in the 21Q2 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 (20Q2-21Q1), the average earnings surprise factor has been 20.1%, well above the long-term surprise factor (since 1994) of 3.7%.

If we assume this trend will continue in 21Q2 and apply the prior four quarter average surprise factor of 20.1% to the companies yet to report, we could potentially see 21Q2 earnings growth improve to 96.4% by the end of earnings season.

If we apply a more conservative surprise factor of 10.0%, 21Q2 earnings growth could improve to 80.2% by the end of earnings season.

Greatest improvement in Cyclical & Value sectors

All but two sectors (Consumer Staples, Utilities) have seen positive revisions to 21Q2 growth expectations since April 1st.  Like 21Q1, the rotation into cyclical and value seems to be at the forefront, as Industrials, Materials, Energy, and Financials have seen the largest upward revisions to earnings growth in 21Q2.

Since April 1st, Industrials earnings growth has improved from 512.8% to 548.2%, an increase of 35.4 ppt.  Materials has improved from 85.5% to 113.3% (+27.8 ppt).  Energy has improved from 196.1% to 223.1% (+26.9 ppt).  Financials has improved from 82.1% to 99.5% (+17.4 ppt).

From an earnings contribution perspective, Financials, Energy, and Industrials are expected to have the largest contribution towards the 21Q2 earnings growth rate of 64.0%.  Financials is currently expected to contribute 14.7 ppt, while Energy is forecasted to contribute 10.6 ppt, and finally Industrials is expected to contribute 9.7 ppt.  These three sectors alone are expected to contribute 34.9 ppt to the 64.0% 21Q2 earnings growth rate, which is over half of the expected contribution towards the overall index growth rate.

Looking at the Russell 1000 Value Index, it is currently trading at a forward P/E of 17.5x compared to a 10-year average of 14.6x, yielding a modest 19.9% premium.  Alternatively, the Russell 1000 Growth Index is trading at a forward P/E of 28.8x, a 47.6% premium to its long-term average of 19.5x.

Exhibit 2: Forward P/E for FTSE Russell Value & Growth Index

Earnings Watch in 21Q2

There are a handful of constituents that will be largely responsible for delivering 21Q2 earnings growth.  Exhibit 3 highlights the top 20 constituents that have the largest earnings contribution (PPT) along with the expected report date, mean estimate, Smart Estimate, and Predicted Surprise (PS).

This basket of constituents is currently expected to contribute 29.5 ppt towards the current forecasted 21Q2 index level earnings growth rate of 64.0%, which is just under 50%.

Most constituents in this basket come from Energy, Financials, and Industrials.  Exxon Mobil, Wells Fargo, and Chevron round up the top 3, all of whom have a positive PS.  Paying attention to the PS will be important, as this will help predict any significant earnings surprise which will ultimately impact the trajectory of the index level growth rate.

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 when the PS is greater or less than 2% / -2%.

Within this basket, 12 constituents are expected to post a positive earnings surprise while two constituents are expected to post a negative earnings surprise.  General Motors (99.2%), Exxon Mobil (16.9%), and United Airlines Holding (15.8%) have the largest PS in this basket.  Conversely, Boeing Co (-7.8%) and Citigroup Inc (-3.2%) are expected to post a negative PS.

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