The peak period of earnings season kicks off this week and we preview the S&P 500 2023 Q4 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
2023 has been far better than expected, as every quarter (Q1, Q2, and Q3) saw an improvement in the final earnings growth rate compared to the start of earnings season while narrowly avoiding an ‘earnings recession.’
During the first three quarters of 2023, Q4 earnings growth expectations remained stable. However, over the last three months, analysts have aggressively downgraded expectations by 640 basis points, far more than what we typically see heading into earnings season.
The only bright spot was Information Technology, the only sector to see both its earnings growth and net profit margin expectations rise, heading into earnings season. The Magnificent Seven have an aggregate earnings growth rate of 52.2% this quarter and are once again pushing the index into positive earnings territory. If the Mag Seven is excluded, earnings growth declines to -3.2%.
More alarming is the trajectory of earnings momentum looking out into 2024, as seven sectors have seen downward revisions to earnings growth for Q1, Q2, and Q3. Full-year growth expectations for 2024 have declined by 100 basis points over the last three months to 11.1%, but are still above the long-term average of 7.6%.
Part 1 – Earnings Growth and Contribution
Using data from the January 19th publication of the S&P 500 Earnings Scorecard, Q4 blended earnings (combining estimates and actuals) are forecasted at $454.2 billion (+4.5% y/y, -7.3% q/q) while revenue is forecasted at $3,867.7 billion (+2.5% y/y, +1.4% q/q).
Ex-energy, earnings growth is forecasted at 8.2%, which marks the third consecutive quarter of positive ex-energy growth. Ex-energy, revenue growth is forecasted at 3.8%.
At a sector level, Industrials is currently expected to snap its streak of positive y/y earnings growth at eleven consecutive quarters, the longest of any sector. Consumer Discretionary, Consumer Staples, and Financials are all expected to see a fourth consecutive quarter of growth. Materials is expected to post a sixth consecutive quarter of earnings decline followed by Health Care at five consecutive quarters.
From an earnings growth contribution perspective, seven sectors have positive earnings contribution while four sectors have negative earnings contribution (Exhibit 1).
Communication Services has the largest growth contribution of any sector and is forecasted to contribute 3.5 percentage points (ppt) towards the index growth rate of 4.5%. Information Technology (3.5 ppt) and Consumer Discretionary (1.5 ppt) are the next largest contributors while Health Care (-3.0 ppt), Energy (-2.9 ppt), and Materials (-0.6 ppt) are the largest detractors to earnings growth this quarter.
Exhibit 1: S&P 500 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. Nvidia, Microsoft and Apple are expected to deliver the lion share of earnings growth for Information Technology. The same can be said for Amazon in Consumer Discretionary for the fourth consecutive quarter (1.6 ppt), and Meta and Alphabet for Communication Services. In other words, the “Magnificent Seven” will yet again be a group to look at closely this quarter.
In the bottom half of the table, Energy dominates the top 10, given difficult year-over-year comparisons. For the fourth consecutive quarter, many of the large pharmaceutical constituents are expected to post negative earnings growth from a strong 2022 when they benefited from vaccine revenues.
Exhibit 1.1: S&P 500 23Q4 Earnings Growth Contribution
Part 2 – Estimate Revisions into Earnings Season
Analysts have aggressively lowered earnings expectations heading into earnings season to levels we haven’t seen since 2022. From a guidance perspective, we have seen 75 negative Q4 EPS pre-announcements compared to 37 positives, resulting in a negative/positive ratio (n/p) of 2.0, which is below the long-term average of 2.5 and in-line with the prior four-quarter average of 2.1. In Q3, we saw 79 negative pre-announcements compared to 41 positive heading into earnings season, yielding a 1.9 n/p ratio.
Over the last three-months, the Q4 EPS estimate has declined from $58.14 to $54.27 per share, resulting in analysts downgrading y/y growth expectations by 6.4 ppt heading into earnings season (Exhibit 2). Q4 growth expectations peaked in the week ending September 29 (+11.0%) and has since fallen 13 out of the last 15 weeks.
Exhibit 2: S&P 500 Earnings Revisions
Exhibit 3 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 Information Technology has seen estimates rise by two percentage points. Materials has seen the weakest momentum for the second consecutive quarter (-13.3 ppt) followed by Industrials (-7.9 ppt), and Utilities (-6.3 ppt).
Over this same period, Information Technology has seen an upgrade in earnings growth expectations for the next three quarters (including Q4). Conversely, Consumer Staples has seen a downgrade in earnings growth expectations for the next five quarters (including Q4). Consumer Discretionary, Energy, Industrials, Materials, Real Estate, and Communication Services have all seen a downgrade in earnings growth expectations for the next four quarters (including Q4).
Exhibit 3: S&P 500 2023 Q4 Estimate Revisions
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.
Information Technology has the largest earnings weight this quarter at 23.5% which is about 6 percentage points lower than its market-cap weight of 29.8%. This results in the largest negative weight differential of all sectors, highlighting the premium on the sector, which has a forward P/E of 27.5x (38% premium vs. S&P 500).
Financials saw a boost to its earnings weight in Q1 due to the GICS Classification change in March, which saw juggernauts Visa and Mastercard move to this sector (previously residing 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 4.5% with a forward P/E of 14.6x.
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 10.7x.
The Magnificent Seven group — Apple, Amazon, Alphabet, Meta, Microsoft, NVIDIA and Tesla has a market cap weight of 28.8% (just below an all-time high) compared to an earnings and revenue weight of 20.3% and 11.2% respectively. The Magnificent Seven group has an aggregate forward four-quarter P/E of 29.1x, a 46% premium to the overall index. When excluding the Mag Seven, the forward P/E declines to 17.5x.
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 LSEG 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.
Paramount Global has seen the largest downgrade in EPS estimates over the last 60 days (-103.2%) followed by Caesars Entertainment Inc (-78.6%), Humana (-36.6%), Warners Bros Discovery Inc (-34.1%), and Pfizer Inc (-33.3%). Note: values less than -100% occur when an EPS estimate turns from positive to negative.
Exhibit 5: Largest Negative Revisions for 2023 Q4
Source: LSEG Workspace
Exhibit 5 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 5.1 displays the same data for constituents with the largest upgrades heading into earnings season.
Exhibit 5.1: Largest Positive Revisions for 2023 Q4
Source: LSEG 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 (Exhibit 6). Net profit margins peaked in 2021 Q2 (12.9%) and which then declined for six consecutive quarters and has since risen for three consecutive quarters.
The Q4 blended net profit margin is 10.7%, a 50-basis point decline from the prior quarter and will potentially end a three-quarter consecutive improvement in margins. We note that Q4 margin expectations have gradually declined over the last three months.
Over the last three months, 10 sectors have seen net margin estimate decline, while one sector have seen an increase. Health Care has seen the largest decline in Q4 margin expectations (-178 bps, current value: 7.0%), followed by Materials (-119 bps, 8.4%), and Energy (-112 bps, 9.6%). Information Technology has seen the largest improvement in margin expectations (45 bps, 24.5%).
The 2023 and 2024 full-year estimate is currently 11.2% and 11.7% respectively, while the forward four-quarter estimate is now equivalent to the 2024 full-year estimate the next three months.
The Magnificent Seven has an aggregate Q4 net margin estimate of 21.2%.
Exhibit 6: S&P 500 Net Margin Expectations
Part 6 – Forward P/E & PEG Ratio
Using LSEG Datastream, the forward 12-month (F12) EPS is $243.36 per share (Exhibit 7) and sits above the 2024 EPS estimate of $238.76 as the weighting of the calculation now takes the 2025 estimate into consideration.
Looking at the data in a different way, the 2023 and 2024 estimate has declined by 12.3% and 10.6% respectively since June 2022. In comparison, the S&P 500 has risen by approximately 28% over the same period.
The S&P 500 forward 12-month P/E ratio (time-weighted basis) shows a current reading of 19.9x, which ranks in the 85th percentile (since 1985) and a 11.8% premium to its 10-year average (17.8x). For reference, the trough forward P/E during the last four recessions were as follows: 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 1.32x which ranks in the 65th percentile (since 1985) and a 6.4% discount to its 10-year average (1.41x).
Exhibit 7: S&P 500 EPS Estimates
Conclusion
Q4 estimates have been downgraded aggressively heading into earnings season which may set a lower bar for corporations to beat analyst expectations and surprise to the upside, as seen in every quarter of 2023 thus far.
We continue to monitor top-line strength and see if Q4 can show any improvement vs. analyst expectations, given the revenue surprise rate reaching a multi-year low last quarter.
Most alarming is the trajectory of estimate revisions looking out to 2024, as seven of the 11 sectors have seen downward revisions to earnings growth expectations for Q1, Q2, and Q3 2024.
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