by Tajinder Dhillon and Thomas Alonso.
Earnings growth remained resilient last quarter in the face of higher inflation, higher interest rates, and a potential ‘hard landing’ as year-over-year earnings and revenue grew by 11.4% and 14.0% respectively along with above-average beat rates of 77.4% and 74.1%.
As we enter 22Q2 earnings season, growth rates remain positive but continue to fall after last year’s outsized pandemic impact as shown in Exhibit 1.
Exhibit 1: S&P 500 YoY Growth Rates
The current 22Q2 earnings growth rate of 5.7% would be the slowest pace of growth since 20Q4 and below the long-term (since 1994) growth rate of 10.9%.
Interestingly, revenue growth is expected to continue to grow at a double-digit pace (10.6%), above the long-term average of 6.0% as top line growth likely continues to benefit from rising prices and higher pricing power for larger companies.
The forward 12-month net profit margin for the S&P 500 is currently at an all-time high of 13.4% and has increased by 280 basis points over the last two years as shown in Exhibit 2. Every sector except for Utilities has seen a rise in profit margin over the last two years.
Certainly, this will be of critical importance as investors look to see if companies are still able to produce record level of margins in the face of higher inflation, wages, and commodity prices.
Exhibit 2: S&P 500 Net Profit Margin
Earnings growth when excluding energy
Exhibit 3 shows 22Q2 earnings and revenue growth rates at an index and sector level. The Energy sector growth rate is currently forecast at 239.1%, which is by far the highest sector. This follows the 269.5% YoY growth in earnings the energy sector posted in 22Q1 as the sector continues to benefit from the sharp rise in price of the underlying commodity.
Exhibit 3: S&P 500 22Q2 Growth Rates
Looking at the change in growth expectations over the past year in Exhibit 4, we can see that the energy sector is only one of only three sectors along with Materials and Real Estate to see estimates move higher.
While overall growth expectations for the S&P 500 have fallen over the year (5.7% vs 14.4% on 7/1/2021), the energy sector has seen estimates increase dramatically (239.1% vs 31.2%).
Exhibit 4: S&P 500 22Q2 Sector Growth Rate History Source: I/B/E/S data from Refinitiv
We can see the importance of the energy sector on 22Q2 earnings expectations which leads us to emphasize the importance of looking at earnings growth by excluding the energy sector. 2022 Q2 earnings growth has a current forecast of 5.7%. However, when energy is excluded, the growth rate declines to -3.0%, which would mark the first negative print since 2020 Q3.
We display earnings growth ex. Energy for 22Q2, 22Q3, and 22Q4 in Exhibit 5 which highlights a downward revision in growth expectations in each of the three quarters which may provide a more realistic view on how we look at growth for the remaining of the year.
Year-to-date, 22Q2 earnings growth ex. Energy has declined from 3.1% to -3.0%. For 22Q3, growth has declined from 7.6% to 5.3% while 22Q4 has seen the largest downward revision from 16.0% to 7.5%.
Exhibit 5: S&P 500 Earnings Growth excluding Energy
Exhibit 6 highlights the same data but looking at full year 2022 and 2023. For 2022, we see a similar trend with the ex-energy growth rate declining over the past year. As a result, the gap between index growth and index ex-energy growth has widened to 5.7 ppts (9.4% vs. 3.8%) as energy prices have increased and analysts have raised estimates.
However, we see this impact reversed in 2023 growth estimates, with total EPS growth for the index below the index ex-energy as YoY growth for the energy sector is expected to be negative in 2023.
Exhibit 6: 2022 and 2023 S&P 500 Earnings Growth excluding Energy
Source: I/B/E/S data from Refinitiv
Earnings Watch in 22Q2
As is usually the case, earnings growth is expected to be driven by a handful of constituents. Exhibit 7 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 11.2 ppt towards the current forecasted 2Q22 index level earnings growth rate of 5.7%, implying the remaining 480 companies will have negative YoY growth. From an earnings contribution perspective, the energy sector is currently forecasted to contribute 8.5 ppts towards the index growth rate of 5.7%, by far the largest of any sector.
Exhibit 7: 22Q2 Earnings Watch
The impact of rising oil prices is visibly evident with half of the top 20 constituents above coming from the energy sector.
Paying attention to the Predicted Surprise 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, 7 constituents are expected to post a positive earnings surprise while just one constituent is expected to post a negative earnings surprise.
Full-Year estimates continue to rise?
Year-to-date, the S&P 500 has declined by 18.2% while 2022 and 2023 earnings growth expectations continue to rise.
Looking at bottom-up EPS estimates for the S&P 500 shows that since the start of the year 2022 and 2023 EPS estimates have increased (Exhibit 8).
Exhibit 8: Bottom Up EPS Estimates for S&P500
Source: I/B/E/S data from Refinitiv
As a result, there appears to be a significant disconnect between market pricing and analyst estimate revisions. This has led the forward P/E multiple to decline from 22.1x at the beginning of the year to a current reading of 16.5x which is near the long-term average of 15.5x (Exhibit 9).
Exhibit 9: S&P 500 P vs. E
22Q2 may turn to be a pivotal quarter as the current decline in equities appears to be driven primarily by higher interest rates and less so by a potential weaker earnings outlook. If we see themes such as increased margin pressure, weaker guidance, a decline in pricing power, or weaker sales growth from companies, this may recalibrate the broken trend in the chart above.
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