by Tajinder Dhillon.
Earnings season kicks off next week and will provide further insight to a myriad of questions – will companies continue to report beats and surprises to the upside? Can companies continue to maintain record-high margins? Will forward earnings estimates start to reflect the economic reality of higher interest rates and a potential recession?
22Q3 earnings are forecasted at $465.32 billion (+4.5% y/y, -1.7% q/q) while revenue is forecasted at $3,644.1 billion (+9.7% y/y, -0.5% q/q). While year-over-year growths remain in positive territory, analysts have downgraded both earnings and revenue growth expectations heading into earnings season.
Earnings growth has come down by 2.6 percentage points (ppt) heading into earnings season. This compares to a long-term average decline of 3.3 ppt and a median decline of 2.2 ppt. The decline in growth expectations this quarter bucks a recent trend where growth expectations have increased heading into earnings season (six of eight times going back to 20Q3).
22Q3 y/y earnings growth peaked in late June (+11.4%, +6.2% ex-energy) which has since declined rapidly (Exhibit 1). More importantly, earnings growth ex-energy has turned negative since August and now reads -2.0%, which would mark the second consecutive quarter of negative ex-energy y/y growth.
This would mark a ‘turning point’ as we’ve only seen ex-energy earnings growth turn negative in two prior periods – the Global Financial Crisis of 2008-2009 and the COVID pandemic of 2020.
Exhibit 1: S&P 500 22Q3 Earnings Growth Rate
From an earnings contribution perspective, the energy sector is currently forecasted to contribute 6.3 ppt towards the index growth rate of 4.5%. Said differently, the energy sector is an earnings contribution greater than all the remaining sectors combined. Industrials (1.8 ppt) and Consumer Discretionary (1.1 ppt) are the next largest contributors while Communication Services (-1.7 ppt) and Financials (-1.6 ppt) are the largest detractors to earnings growth this quarter (Exhibit 2).
While Energy is contributing the lion share of earnings growth from a year-over-year perspective, the sector is expected to post a quarter-over-quarter decline in earnings growth (-14.3%), which would mark the first quarterly decline dating back to 21Q1 and put further pressure on the breadth of earnings growth.
Exhibit 2: S&P 500 22Q3 Earnings Growth Contribution
Using the Screener app in Refinitiv Workspace, we can screen for yet-to-report constituents that have seen the largest upgrades and downgrades heading into earnings season.
Exhibit 3 highlights companies who have seen earnings downgrades of at least 10% as defined by the 30-day mean estimate change in ‘Preferred Earnings’. Preferred Earnings is defined as EPS for most companies except for Real Estate where it can be either EPS or FFOPS depending on analyst coverage.
Warner Bros Discovery Inc has seen the largest downgrade in EPS estimates over the last 30 days (-41.5%) followed by Ford Motor Co. (-24.0%), Eastman Chemical Co (-22.7%), Dow Inc (-22.4%), and Boeing Co (-21.1%).
Exhibit 3: Negative Revision for 22Q3
Exhibit 3 also displays the Predicted Surprise (PS) for each constituent, which compares the SmartEstimate vs. Mean Estimate. A PS greater than 2% or less than -2% is deemed significant as our research shows that StarMine will accurately predict the direction of the earnings surprise 70% of the time.
The StarMine SmartEstimate is a quantitative analytic which is used as an input to many of the StarMine models. The SmartEstimate places a greater weight on higher ranked analysts who are more accurate and timelier.
We see a positive correlation between constituents who have seen a large downgrade and a corresponding negative PS. Furthermore, a positive correlation is shown between the mean estimate change vs. Analyst Revision Model (ARM) score (i.e., companies that have seen large downward earnings revision also have a low ARM score).
ARM is a percentile stock ranking model that is designed to predict future changes in analyst sentiment by looking at changes in estimates across EPS, EBITDA, Revenue, and Recommendations over multiple time periods.
The last two columns in Exhibit 3 display both the current ARM score and its 30-day change. For example, Ford Motor Co has an ARM score of 26 (ranked vs. regional peers) and its ARM score has declined by 25 over the last 30 days.
Looking at the Predicted Surprise and ARM columns can be very useful during earnings season to assess the likelihood of whether companies are expected to beat or miss earnings while at the same time gauging analyst sentiment.
Exhibit 4 displays the same data for constituents with the largest upgrades heading into earnings season.
Exhibit 4: Positive Revisions for 22Q3
Forward 12-month margin expectations are at an all-time high despite rising input cost pressures from higher wages and commodity prices which can be partially explained to pricing power as consumers borne the cost.
Using data from the S&P 500 Earnings Scorecard (subscribe here), we look at net profit margins for the S&P 500 (Exhibit 5). We compare margin estimates on Sep 23, 2022 vs. estimates at the same time one-year ago and note a slight deterioration in 22Q3 (11.8% vs. 12.2%) and 22Q4 (11.6% vs. 12.1%), both of which have declined by 0.5 percentage points.
Energy has seen the largest increase for 22Q3, followed by Real Estate and Utilities. Seven sectors have seen margin expectations decline in 22Q3 – Communication Services with the largest decline, followed by Technology, Consumer Discretionary, Industrials, and Consumer Staples.
Looking ahead to 22Q4, Energy again has seen margin expectations increase over the last year but are expected to decline vs. 22Q3 (11.7% vs. 13.2%) while Information Technology is expected to see its margin increase vs. 22Q3 (24.3% vs. 22.7%).
Exhibit 5: S&P 500 Net Margin Expectations
If companies highlight margin pressure this quarter, we expect margin expectations to further decline and filter through into the bottom-up EPS estimate for the index. As per Refinitiv Datastream, forward 12-month EPS estimates have increased year-to-date (+6.2%) to $234.2 per share while the S&P 500 has declined 23.4% over the same period, leading to one of the largest gaps between ‘P’ vs. ‘E’ in recent years (Exhibit 6).
More striking is the trajectory in the forward 12-month EPS ex. Energy estimates ($162.1 per share), which has declined 12.2% since February.
Exhibit 6: S&P 500 ‘P’ vs. ‘E’
Markets are looking to companies to provide commentary on several issues from the macro-outlook, health of the consumer, supply chain management, impact of inflation and higher input costs, hiring plans, and the strength of the U.S. dollar which will generate headwinds for companies with international revenue exposure.
Given the host of worries noted above, we may see an increase in companies either a) withdrawing forward guidance, or b) lowering forward guidance which will bring further downward revisions to earnings and revenue estimates.
Refinitiv Workspace is a complete solution for research and analytics. It places the most comprehensive market information, news, analytics and trading tools available into a desktop.
Refinitiv I/B/E/S Estimates are a market leader, boasting 200+ metrics and indicators across 15 industries. Find more information on our estimates data.
Get unique value-add analytics and predictive financial modeling, dedicated to making investment research smarter with Refinitiv StarMine data.