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April 11, 2023

S&P 500 2023 Q1 Earnings Preview: Entering an Earnings Recession

by Tajinder Dhillon.

Earnings season kicks off this week and using data from the April 7th publication of the S&P 500 Earnings Scorecard, 2023 Q1 blended earnings (combining estimates and actuals) are forecasted at $419.1 billion (-5.2% y/y, -4.7% q/q) while revenue is forecasted at $3,558.4 billion (+1.6% y/y, -5.5% q/q).

Q1 is expected to mark the second consecutive quarter of negative y/y earnings growth (third consecutive quarter of negative q/q growth) which meets the criteria of an earnings recession. Furthermore, Q1 aggregate earnings have declined by 11.5% from its high watermark set in 2022 Q2, when the index achieved $473.5 billion in earnings.  Finally, Q1 earnings growth is forecasted to be the lowest y/y growth rate since 2020 Q3.

The prior earnings recession started in 2020 Q2, lasting three quarters from start to finish.  Today’s earnings recession may also last three quarters if analyst expectations turn out to be correct as 2023 Q2 y/y growth is forecasted at -4.0%.

Part 1 – Estimate Revisions into Earnings Season

Analysts have set the bar lower heading into earnings season by downgrading Q1 estimates.  From a guidance perspective, we have seen 81 negative Q1 EPS pre-announcements compared to 26 positives, resulting in a negative/positive ratio of 3.1, which is at a four-year high.

Q1 y/y earnings growth has come down by 3.0 percentage points (ppt) over the last two months, which is in-line with the long-term average decline of 3.2 ppt and a median decline of 2.2 ppt.

While we traditionally track revisions data two months prior to earnings season (which forms our long-term and median data points above), we also decided to look at revisions three months prior to get a more complete picture of analyst revisions.  Over the last three-months, the Q1 EPS estimate has declined from $54.05 to $50.63 per share, resulting in analysts downgrading y/y growth expectations by 6.4 ppt heading into earnings season (Exhibit 1).  We’ve seen analysts revise downwards by a similar amount in the prior two quarters as well (-7.4 ppt and -6.6 ppt).

We are seeing the early impact of a lower bar set by analysts as we start earnings season.  All 20 constituents that have reported Q1 earnings beat analyst expectations in addition to an aggregate 14.8% earnings surprise factor, which is at a multi-quarter high.

Exhibit 1: S&P 500 Earnings Revisions

Exhibit 2 highlights the trajectory of Q1 earnings growth, which peaked in April 2022 (+13.7%, +15.2% ex-energy) and has now reset to -5.2% y/y and -6.7% ex-energy.  Interestingly, the majority of Q1 downgrades finished by the beginning of March and has remained stable since (even after the banking collapse), which may indicate that analysts are adopting a ‘wait-and-see’ approach once new information is presented from companies.

Furthermore, ex-energy earnings growth is expected to be negative for the fourth consecutive quarter, surpassing the three quarters of negative ex-energy growth seen in 2020.

At a sector level, both Energy and Industrials are expected to continue its streak of positive y/y earnings growth at nine consecutive quarters.  Financials are expected to post a positive y/y earnings growth this quarter after four consecutive quarters of negative growth.

Communication Services is expected to post its fifth consecutive quarter of negative y/y earnings growth, followed by Utilities at four consecutive quarters, and Information Technology and Materials both at three consecutive quarters.

Exhibit 2: S&P 500 2023 Q1 Earnings Growth Rate

Part 2 – Earnings Growth Contribution

From an earnings growth contribution perspective, four sectors have positive earnings contribution while seven sectors have negative earnings contribution (Exhibit 3).

Consumer Discretionary has the largest positive contribution of any sector and is forecasted to contribute 1.6 percentage points (ppt) towards the index growth rate of -5.2%.  Industrials (1.0 ppt) and Energy (1.0 ppt) are the next largest contributors while Health Care (-3.5 ppt), Information Technology (-2.9 ppt), and Materials (-1.3 ppt) are the largest detractors to earnings growth this quarter.

We point out that Energy is no longer the ‘top dog’ from an earnings growth contribution perspective, which has been the trend in recent quarters.  Instead, the sector now faces more difficult year-over-year comparisons going forward given the banner year of 2022, where the sector recorded close to $200 billion in earnings.

Exhibit 3: S&P 500 23Q1 Earnings Growth Contribution by Sector

We also look at earnings growth contribution at a constituent level in Exhibit 3.1 and highlight the top 10 and bottom 10 contributors.  Amazon.com Inc is expected to deliver the lion share of earnings growth for Consumer Discretionary this quarter (1.2 ppt) while the same can be said for JPMorgan Chase & Co for the Financials sector (0.5 ppt).

Within Industrials, all three constituents in the top half of the table are related to the airline industry and are mainly benefitting from easy year-over-year comparisons, which can be considered a lower quality of earnings contribution.

In the bottom half of the table, Semiconductors continue to weigh down Information Technology while many of the large pharmaceutical constituents are expected to post negative earnings growth as it largely benefitted from vaccine sales last year.

Exhibit 3.1: S&P 500 23Q1 Earnings Growth Contribution by Constituent

To put Exhibit 3.1 into further perspective, we outline a range of outcomes in the 23Q1 earnings growth rate if we exclude the top and bottom individual earnings contributors.  When doing this, we observe a potential earnings growth rate ranging from -7.6% to -2.5% (-5.0% when excluding both top and bottom contributors).

More specifically, when excluding the top three positive earnings contributors, the earnings growth rate declines from -5.2% to -7.6%.  When excluding the top three negative contributors, the earnings growth rate improves from -5.2% to -2.5%.

If we exclude both the top three positive and top three negative contributors, the growth rate changes from -5.2% to -5.0%.

Part 3 – Market Cap vs. Earnings Weights

Exhibit 4 looks at the difference between ‘market-cap’ and ‘share-weighted’ weights for the S&P 500 sectors.  The S&P 500 Earnings Scorecard utilizes a share-weighted methodology as opposed to a traditional market-cap weighting.

Financials has the largest earnings weight this quarter at 19.6%, which is 1.5 times greater than its market-cap weight of 12.8%.  This results in the largest weight differential of all sectors, highlighting the reliance on Financials to deliver earnings this quarter.  The sector is also attractively valued at a forward P/E of 12.8x (30% discount vs. S&P 500).

Financials saw a boost to its earnings weight due to the GICS Classification change in March, which saw juggernauts Visa Inc and Mastercard Inc move to this sector (previously resided in Information Technology.  To read more about this, please look at our prior note on this subject: 2023 GICS Classification Change: Impact on S&P 500 Earnings, March 27, 2023.

Energy also has a large earnings weight differential (9.1% earnings weight vs. 4.8% market-cap weight), a trend we’ve observed in prior quarters as well.  Energy continues to overdeliver on earnings relative to its market cap weight (which has doubled since September 2021) and trades at the cheapest valuation of any sector at 10.3x.

Conversely, we see the opposite in Information Technology, which has a market-cap weight of 25.8%, but is only expected to deliver 18.5% and 10.1% of the aggregate earnings and revenue this quarter.  This creates the largest negative weight differential and highlighting the premium assigned to this sector with a forward P/E of 24.5x.

Exhibit 4: Market Cap vs. Share-Weight for S&P 500 Sectors

Part 4 – Which companies have seen the largest revisions heading into earnings season?

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 5 highlights companies who have seen earnings downgrades as defined by the 60-day mean estimate change in ‘EQ1 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.

Moderna Inc has seen the largest downgrade in EPS estimates over the last 60 days (-399.7%) followed by United Airline Holdings (-168.1%), Newell Brands (-115.9%), Hasbro Inc (-93.0%), and Illumina Inc (-93.0%). Note: values less than -100% occur when an EPS estimate turns from positive to negative.

Exhibit 5: Largest Negative Revisions for 2023 Q1

Source: Refinitiv Workspace

Exhibit 5 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 display both the current ARM score and its 30-day change.

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 5.1 displays the same data for constituents with the largest upgrades heading into earnings season.

Exhibit 5.1: Largest Positive Revisions for 2023 Q1

Source: Refinitiv Workspace

Part 5 – Net Profit Margin Expectations

Using data from the S&P 500 Earnings Scorecard (subscribe here), we look at quarterly net profit margins using point-in-time actual reported data (Exhibit 6).  Net profit margins peaked in 2021 Q2 (12.9%) and have declined for six consecutive quarters to 10.7%.

The 2023 Q1 blended net profit margin (combining estimates and actuals) is currently forecasted at 10.8%, a slight tick-up from the prior quarter.  However, 2023 Q1 margin expectations have declined by 80 basis points over the last three months which may lead us lower for a potential seventh consecutive quarter.

Over the last three months, every sector except for Financials has seen its net margin estimate decline.  Energy has seen the largest decline in 2023 Q1 margin expectations (-140 bps, current value: 12.0%), followed by Health Care (-140 bps, 9.1%), and Information Technology (-110 bps, 20.8%).  Financials has seen its estimate rise by 50 bps to a current reading of 19.1%.

The 2023 full-year estimate is currently 11.2% (-50 bps), while the forward four-quarter (23Q2-24Q1) net margin is 11.4% (-20 bps).

Exhibit 6: S&P 500 Net Margin Expectations

Exhibit 6.1 looks at the difference between y/y earnings growth and y/y revenue growth on a quarterly basis since 2016.  A positive bar indicates earnings growth is greater than revenue growth (improving net margins) while a negative bar indicates the opposite.

2021 saw a sharp rise in margins post-COVID, as supply-chain bottlenecks in conjunction with soaring demand resulted in higher inflation.  This led to stronger pricing power and boosted top-line growth for S&P 500 companies.  At the same time, companies aggressively reduced their cost base during the height of the pandemic.  This dynamic resulted in record levels of profit margins.  We validate this by highlighting 2021 Q2, which saw a positive differential of 71.1 percentage points, marking the second highest quarterly value since 2000.

One year later, we are in a new world marked by higher interest rates, commodity prices, and input costs (wages).  As a result, 2023 Q1 earnings growth is less than revenue growth by -6.8 ppt, marking the fifth consecutive negative quarterly print and expected to remain negative until next quarter.  This will likely put further pressure on net profit margins in the short-term.

Exhibit 6.1: S&P 500 Earnings Growth vs. Revenue Growth

Part 6 – Forward P/E & PEG Ratio

Using Refinitiv Datastream, the forward 12-month EPS peaked in June 2022 ($238.23 per share) and has since declined by 5.8% to $224.51 (Exhibit 7).

When deconstructing the P/E ratio into ‘Price’ and ‘Earnings’, we continue to see one of the largest gaps between the two in recent years.

The S&P 500 forward 12-month P/E ratio is 18.3x, which ranks in the 80th percentile (since 1985) and a 4.6% premium to its 10-year average (17.5x). For reference, the trough forward P/E during the last four recessions were as followed: 10.1x (Oct 1990), 17.3x (Sept 2001), 8.9x (Nov 2008), and 13.0x (March 2020).

Furthermore, the S&P 500 ‘PEG’ ratio is currently 1.9x which ranks in the 98th percentile (since 1985) and a 35.7% premium to its 10-year average (1.4x).  The PEG ratio is expensive as the forward P/E continues to rise since the October low, while the long-term EPS growth rate expectations continue to decline.

Exhibit 7: S&P 500 ‘P’ vs. ‘E’


Q1 marks the start of an official earnings recession with y/y earnings growth expected to remain negative until next quarter.  Full year 2023 earnings growth is currently forecasted at 0.9%, the lowest since 2015.

Q1 estimates have declined significantly heading into earnings season which may set a lower bar for corporations to beat analyst expectations and surprise to the upside.  The quality of a beat will matter, as investors look to hear from company management on numerous themes including the macro-outlook, health of the consumer, impact of higher input costs on margins, employee hiring (or layoffs), and future capital expenditure plans.

To subscribe to the S&P 500 Earnings Scorecard, please click here.

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