Earnings season kicks off this week and we preview the S&P 500 2023 Q2 earnings season in more detail, providing both aggregate and company-level insights using data from I/B/E/S, StarMine, and Datastream, which are all found in the desktop solution Refinitiv Workspace.
Using data from the July 7th publication of the S&P 500 Earnings Scorecard, Q2 blended earnings (combining estimates and actuals) are forecasted at $436.9 billion (-6.4% y/y, -0.9% q/q) while revenue is forecasted at $3,661.9 billion (-0.8% y/y, +0.6% q/q). The last time both earnings and revenue y/y growth declined in the same quarter occurred in 2020 Q3.
Heading into the Q1 earnings season, we were expecting an ‘earnings recession’ based on a negative Q4 actual growth rate along with analyst estimates forecasting a negative growth rate for both Q1 and Q2. However, Q1 marked a resilient (and suspenseful) quarter which threw water on the earnings recession narrative as the growth rate finished at +0.1% from a starting point of -5.1% at the beginning of the quarter. It was a suspenseful ending to earnings season as many readers waited to see if the Q1 growth rate would turn to positive territory and eventually did at the last minute. This was a remarkable feat as we have only seen the growth rate start negative and end positive on eight occasions since 2002.
Looking at Q2, the backdrop heading into the quarter looks remarkably similar to Q1 (Exhibit 1) which raises the question – will we see ‘A Repeat Performance’ of last quarter?
Exhibit 1: S&P 500 Earnings Growth Rate
Part 1 – Estimate Revisions into Earnings Season
Surprisingly, the upbeat Q1 did not translate into upward Q2 growth expectations. Instead, analysts have set the bar lower heading into earnings season by downgrading Q2 estimates, albeit at a slower pace compared to the prior three quarters. From a guidance perspective, we have seen 62 negative Q2 EPS pre-announcements compared to 39 positives, resulting in a negative/positive ratio of 1.6, which is below the long-term average of 2.5 and the prior four-quarter average of 2.0.
Over the last three-months, the Q2 EPS estimate has declined from $54.24 to $52.81 per share, resulting in analysts downgrading y/y growth expectations by 2.5 ppt heading into earnings season (Exhibit 2). Interestingly, the majority of Q2 downgrades finished by the beginning of May and remained unchanged throughout the month of May and June. Finally, Q2 has seen a slower pace of revisions compared to the prior three quarters where estimates were revised downwards by an average of 6.8 ppt.
Exhibit 2: S&P 500 Earnings Revisions
Exhibit 3 highlights the trajectory of Q2 earnings growth, which peaked in May 2022 (+11.8%, +15.1% ex-energy) and has now reset to -6.4% y/y and -0.7% ex-energy. We highlight the latter as Energy is a material drag to the index growth rate (more details in Part 2 below), which is not usually the case – the last time we saw this dynamic was during the 2020 pandemic where oil prices tumbled.
Furthermore, ex-energy earnings growth is currently forecasted to be negative for the fifth consecutive quarter, surpassing the three quarters of negative ex-energy growth seen in 2020.
At a sector level, Industrials is expected to continue its streak of positive y/y earnings growth at ten consecutive quarters, while Energy’s streak of nine consecutive quarters of growth is expected to finish. Communication Services and Utilities are forecasted to post a positive y/y earnings growth this quarter after five (and four) consecutive quarters of negative growth respectively.
Information Technology and Basic Materials are forecasted to post its fourth consecutive quarter of negative earnings growth, followed by Real Estate and Health Care at three consecutive quarters.
Exhibit 3: S&P 500 2023 Q2 Earnings Growth Rate
Part 2 – Earnings Growth Contribution
From an earnings growth contribution perspective, six sectors have positive earnings contribution while five sectors have negative earnings contribution (Exhibit 4).
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 -6.4%. Financials (0.9 ppt) and Communication Services (0.7 ppt) are the next largest contributors while Energy (-5.7 ppt), Health Care (-2.7 ppt), and Materials (-1.2 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. Therefore, looking at quarterly growth rates will be more effective to gauge earnings performance this year. Energy is forecasted to post Q2 aggregate earnings of $32.0 billion, a 20.0% decline from Q1.
Exhibit 4: S&P 500 23Q2 Earnings Growth Contribution
We also look at earnings growth contribution at a constituent level in Exhibit 4.1 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 for the second consecutive quarter (1.1 ppt) while the same can be said for JPMorgan Chase & Co (0.8 ppt) and Wells Fargo Inc (0.4 ppt) for the Financials sector.
In the bottom half of the table, Energy dominates the top 10 as explained above. For the second consecutive quarter, many of the large pharmaceutical constituents are expected to post negative earnings growth from a strong 2022 when it benefitted from vaccine revenues.
Exhibit 4.1: S&P 500 23Q2 Earnings Growth Contribution
To put Exhibit 4.1 into further perspective, we outline a range of outcomes in the Q2 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 -9.0% to -2.0% (-4.6% when excluding both top and bottom contributors).
More specifically, when excluding the top three positive earnings contributors, the earnings growth rate declines from -6.4% to -9.0%. When excluding the top three negative contributors, the earnings growth rate improves from -6.4% to -2.0%.
If we exclude both the top three positive and top three negative contributors, the growth rate changes from -6.4% to -4.6%.
Part 3 – Market Cap vs. Earnings Weights
Exhibit 5 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.
Information Technology has the largest earnings weight this quarter at 18.2%, which is 1.5 times lower than its market-cap weight of 28.2%. This results in the largest weight differential of all sectors, highlighting the premium on the sector, which has a forward P/E of 27.1x (41% premium vs. S&P 500).
Financials saw a boost to its earnings weight last quarter 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. The sector has the largest positive earnings weight differential at 5.6% with a forward P/E of 13.4x.
While Energy’s positive weight differential has declined compared to prior quarters, the sector 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 10.6x.
The ‘Magnificent-7’ group comprising of Apple Inc, Amazon.com Inc, Alphabet Inc, Meta Platforms Inc, Microsoft Corp, NVIDIA Corp, and Tesla Inc has a market cap weight of 27.9% compared to an earnings and revenue weight of 14.0% and 9.3% respectively. The ‘Magnificent-7’ group has an aggregate forward P/E of 33.2x, a 73.0% premium to the overall index.
Exhibit 5: 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 6 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.
Allstate Corp has seen the largest downgrade in EPS estimates over the last 60 days (-752.6%) followed by EQT Corp (-158.2%), Catalent Inc (-86.7%), Paramount Global (-14.4%), and Tyson Foods (-66.8%). Note: values less than -100% occur when an EPS estimate turns from positive to negative.
Exhibit 6: Largest Negative Revisions for 2023 Q2
Source: Refinitiv Workspace
Exhibit 6 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 6.1 displays the same data for constituents with the largest upgrades heading into earnings season.
Exhibit 6.1: Largest Positive Revisions for 2023 Q2
Source: Refinitiv Workspace
Nvidia Corp ranks second in Exhibit 6.1, which has seen its consensus estimate rise from $1.05 to $2.05 over the last 60 days after a positive pre-announcement in May. Nvidia is part of the ‘Magnificent-7’ group which has delivered the bulk of stock performance year-to-date as highlighted in a prior note (Large-Cap U.S. Equities Showing Narrow Breadth in Year-to-Date Performance, May 31, 2023).
Part 5 – Net Profit Margin Expectations
Using data from the S&P 500 Earnings Scorecard (subscribe here), we look at quarterly net profit margins (Exhibit 7). Net profit margins peaked in 2021 Q2 (12.9%) and which then declined for six consecutive quarters to 10.7% and rose to 11.2% in 2023 Q1.
The Q2 blended net profit margin (combining estimates and actuals) is currently forecasted at 10.9%, a slight decline from the prior quarter. We note that Q2 margin expectations have declined by 26 basis points over the last three months.
Over the last three months, seven sectors have seen its net margin estimate decline, while four sectors have seen an increase. Energy has seen the largest decline in Q2 margin expectations (-155 bps, current value: 10.2%), followed by Financials (-77 bps, 18.1%), and Basic Materials (-69 bps, 10.7%). Information Technology has seen its estimate rise by 64 bps to a current reading of 21.5%..
The 2023 and 2024 full-year estimate is currently 11.1% and 11.7% respectively, while the forward four-quarter estimate is 11.4%.
Exhibit 7: S&P 500 Net Margin Expectations
Part 6 – Forward P/E & PEG Ratio
Using Refinitiv Datastream, the forward 12-month (F12) EPS peaked in June 2022 ($238.23 per share) and has since declined by 3.6% to $229.65 (Exhibit 8). However, it is important to note that the F12 EPS estimate continues to have a larger weighting towards the 2024 estimate as each day passes which distorts the revision figure highlighted above.
For a more accurate picture, the 2023 and 2024 estimate have declined by 11.9% and 9.7% respectively since June 2022. In comparison, the S&P 500 has risen by approximately 20% over the same period.
The S&P 500 forward 12-month P/E ratio is 19.2x, which ranks in the 84th percentile (since 1985) and a 9.2% 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 1.99x which ranks in the 98th percentile (since 1985) and a 42.3% premium to its 10-year average (1.3x). 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 have sharply declined 2021.
Exhibit 8: S&P 500 EPS Estimates
Conclusion
Q2 has a remarkably similar backdrop to last quarter, and we wait to see if a repeat performance can occur. Full year 2023 earnings growth is currently forecasted at 1.0%, the lowest since 2015.
Q2 estimates have declined modestly 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), capital expenditure plans, and artificial intelligence.
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