Earnings season is in full swing and we preview the Russell 2000 Q4 2023 earnings season in granular 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 LSEG Workspace.
Earnings Commentary
Q4 marks the end of a difficult year for Russell 2000 earnings. 2023 full-year earnings growth is currently -11.6%.
Like last quarter, analysts have aggressively downgraded earnings growth expectations heading into earnings season. Over the last three months, Q4 growth expectations were revised downwards by 15.4 percentage points (ppt) to a current growth rate of -11.3%. This downgrade surpasses last quarter, where analysts downgraded by 11.8 ppt heading into earnings season. This sets the bar lower for Q4 and for reference, Q3 saw its final growth rate improve throughout the quarter by 650 basis points.
Communication Services, Consumer Staples, and Materials saw the largest downward revisions in Q4 earnings, while Health Care was the only sector to see an upward revision heading into earnings season, albeit minimal.
Net profit margin expectations have remained flat but are expected to rise materially to 4.8% by the end of 2024, according to analyst estimates.
Q4 revenue q/q growth is currently -0.6% which would mark the second consecutive quarter of negative growth, while y/y growth is forecasted to be negative for the third consecutive quarter. While still early in the reporting season, only 44.7% of constituents have beaten revenue expectations, which is the lowest since tracking this data.
Part 1 – Earnings Growth and Contribution
Using data from the January 25th publication of the Russell 2000 Earnings Scorecard, Q4 blended earnings are forecasted at $21.0 billion (-11.3% y/y, -2.0% q/q) while revenue is forecasted at $465.5 billion (-1.7% y/y, -0.6% q/q).
Ex-energy, earnings growth is forecasted at -3.6%, which marks the fourth consecutive quarter of negative ex-energy growth. Ex-energy, revenue growth is forecasted at -0.6%, marking the third consecutive quarter of negative growth.
From an earnings growth contribution perspective, three sectors have positive earnings growth contribution while eight sectors have negative earnings growth contribution (Exhibit 1).
Health Care has the largest earnings growth contribution of any sector and is forecasted to contribute 4.3 percentage points (ppt). Real Estate (1.9 ppt) and Utilities (0.0 ppt) are the next largest contributors while Energy (-8.6 ppt), Communication Services (-3.9 ppt), and Financials (-2.4 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 $20 billion in earnings. Therefore, looking at quarterly growth rates will be more effective to gauge earnings performance in 2023. Energy is forecasted to post Q4 aggregate earnings of $3.7 billion, which translates to a q/q growth rate of -34.1%.
Exhibit 1: Russell 2000 23Q4 Earnings Growth Contribution
We also look at earnings growth contribution at a constituent level in Exhibit 1.1 and highlight the top 10 and bottom 10 contributors. Multiplan, PTC Therapeutics, and Novavax are expected to deliver the lion’s share of earnings growth for Health Care, albeit due to easier year-over-year comparisons. The same can be said for Safehold and Opendoor Technologies in Real Estate.
In the bottom half of the table, PBF Energy (-2.01 ppt) is forecasted to be the largest individual detractor to earnings growth this quarter followed by Lumen Technologies (-1.87 ppt), and Peabody Energy (-1.20 ppt).
Exhibit 1.1: Russell 2000 23Q4 Earnings Growth Contribution
Part 2 – Estimate Revisions into Earnings Season
Analysts have aggressively lowered earnings expectations heading into earnings season. Over the last three months, the Q4 EPS estimate has declined from $20.01 to $16.96 per share, resulting in analysts downgrading y/y growth expectations by 15.2 percent.
Exhibit 2 highlights earnings momentum at a sector level, defined as the rate of change in Q4 growth expectations over the last three months, expressed in percentage points. All but one sector has seen a positive earnings momentum this quarter as Health Care has seen estimates rise by one and a half percentage points. Communication Services has seen the weakest momentum this quarter (-34.4 ppt) followed by Consumer Staples (-21.9 ppt), and Materials (-18.7 ppt).
Over this same period, Health Care is the only sector to see an upgrade in earnings growth expectations for the next five quarters (including Q4). Conversely, Consumer Discretionary, Consumer Staples, Energy, Industrials, Materials, Information Technology, and Communication Services have all seen a downgrade in earnings growth expectations for the next four quarters (including Q4).
Exhibit 2: Russell 2000 2023 Q4 Estimate Revisions
Part 3 – Market Cap vs. Earnings Weights
Exhibit 3 looks at the difference between ‘market-cap’ and ‘share-weighted’ weights for the Russell 2000 sectors. The Russell 2000 Earnings Scorecard utilizes a share-weighted methodology.
Financials has the largest earnings weight for the second consecutive quarter at 36.6%, which is more than 2 times greater than its market-cap weight of 17.0%. This results in the largest earnings weight differential of all sectors yet trades at a discount vs. the overall index from a valuation perspective with a forward four-quarter P/E of 11.4x.
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 (earnings weight of 17.4% vs. market-cap weight of 7.0%) and trades at the cheapest valuation of any sector at 8.8x.
Exhibit 3: Market Cap vs. Share-Weight for Russell 2000 Sectors
Part 4 – Which companies have seen the largest revisions heading into earnings season?
Using the Screener app in LSEG Workspace, we can screen for yet-to-report constituents that have seen the largest upgrades and downgrades heading into earnings season.
In this example, we show the 60-day percent change in the consensus Preferred Earnings mean estimate for the current quarter (Exhibit 4). We include a filter to only include companies that have at least five analyst estimates. 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.
Delek US Holdings has seen the largest downgrade in the Preferred Earnings estimate over the last 60 days (-3,001.4%) followed by TPG RE Finance Trust (-439.1%), Vertex Energy (-209.4%), Big Lots (-200.0%), and Lumen Technologies (-199.0%). Note: values less than -100% occur when an EPS estimate turns from positive to negative.
Exhibit 4: Largest Negative Revisions for 2023 Q4
Source: LSEG Workspace
Exhibit 4 also displays the StarMine Predicted Surprise (PS%) for each constituent, which compares the SmartEstimate© vs. Mean Estimate. The PS% is a powerful quantitative analytic that compares the StarMine SmartEstimate© to the consensus mean. The SmartEstimate places a higher weight on analysts who are more accurate and timelier, thus providing 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 than 2% of less than -2%.
The StarMine SmartEstimate© is a quantitative analytic which is used as an input to many of the StarMine models.
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. he 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.
The screener app provides a powerful workflow tool for Analysts and Portfolio Managers looking to parse through hundreds of companies during earnings season to identify thematic trends.
Exhibit 4.1 displays the same data for constituents with the largest upgrades heading into earnings season.
The screener app provides a powerful workflow tool for Analysts and Portfolio Managers looking to parse through hundreds of companies during earnings season to identify thematic trends.
Exhibit 4.1: Largest Positive Revisions for 2023 Q4
Source: LSEG Workspace
Part 5 – Net Profit Margin Expectations
Using data from the Russell 2000 Earnings Scorecard, we look at quarterly net profit margins (Exhibit 5). The Q4 blended net profit margin is 3.4%, a slight decline from the prior quarter. Over the next year, margin expectations are gradually rising according to analyst estimates.
Over the last three months, every sector except for Health Care has seen its net margin estimate decline. Utilities has seen the largest decline in margin expectations (-214 bps, current value: 9.9%), followed by Energy (-170 bps, 6.6%), and Real Estate (-147 bps, 1.0%). Health Care has seen the largest improvement in margin expectations (+6 bps, -14.5%).
The 2023 and 2024 full-year estimate is currently 3.5% and 4.2% respectively, while the forward four-quarter estimate is now equivalent to the 2024 full-year estimate for the next three months.
Exhibit 5: Russell 2000 Net Profit Margin Expectations
Part 6 – Forward P/E & PEG Ratio
Using LSEG Workspace, the forward 12-month EPS is currently $89.27 per share which yields a forward P/E of 22.3x.
The 2023 and 2024 EPS estimate of $69.19 and $86.78 per share have declined by 19.9% and 19.5% respectively over the last year (Exhibit 6). In comparison, the Russell 2000 price index has risen by approximately 4.5% over the same period.
Using LSEG Datastream, the Russell 2000 forward 12-month P/E ratio has risen over the last three months to a current reading of 22.3x, which ranks in the 52nd percentile (since 2002) and a 10.3% discount to its 10-year average (24.8x). For reference, the trough forward P/E during the last two recessions were as followed: 13.2x (Nov 2008) and 16.1x (March 2020).
Furthermore, the Russell 2000 ‘PEG’ ratio is currently 1.55x which ranks in the 72nd percentile (since 2002) and a 4.3% discount to its 10-year average (1.62x).
Exhibit 6: Russell 2000 EPS Estimates
Conclusion
Analysts have aggressively lowered earnings expectations heading into earnings season, which sets the bar lower to see a positive earnings surprise, as seen in the prior two quarters.
Looking ahead to 2024 earnings, full-year growth expectations are currently 27.8%, which has been declining gradually over the last four months and a datapoint to monitor closely. We are seeing a similar trend in 2024 revenue, where growth expectations have been declining since August.
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