We claimed last week that ‘there was nothing to cheer about in Q3 earnings’ (for last week's report, click here).
As evidence to support that claim, we cited the relatively low beat ratios as indicative of companies struggling to come ahead of earnings and revenue expectations that had come down sharply during the quarter. We also referred to how the earnings and revenue growth rates were tracking lower than what we had seen in Q2 and the preceding few quarters. At the time, we had seen results from a Finance-heavy sample of 99 S&P 500 members.
With results from another 145 S&P members since then, the Q3 earnings picture has improved quite a bit. Guidance still remains on the weak side, prompting estimates for Q4 to come down steadily. But the scorecard for Q3 has bloomed lately, with growth rates and beat ratios that were earlier tracking below the last few quarters now outpacing them. Companies aren’t struggling to beat the lowered estimates, which makes perfect sense how low expectations had fallen in the run to the start of the Q3 earnings season.
We have another super-busy week of earnings reports this week, with more than 750 companies including 124 S&P 500 members reporting results. With results from 244 S&P 500 members accounting for almost 55% of the index’s total market capitalization already out, we now have a fairly good sense how this earnings season is unfolding. Judging by the earnings reports seen thus far, the Q3 earnings season appears on track to be better than the Q2 earnings season in terms of growth rates and surprises.
Q3 Earnings Scorecard (as of Friday, 10/25/2013)
Total earnings for the 244 S&P 500 companies that have reported results are up +8.1% with 68% beating earnings expectations, while total revenues for these companies are up +3.4% and 48.8% are beating top-line expectations. The table below shows the current earnings scorecard.
This is better performance than what this same group of 244 companies in Q2 and the 4-quarter average, though revenue growth is a bit light. As you can see in the chart below, the ratio of companies coming ahead of earnings expectations is significantly better than Q2 and modestly so relative to the 4-quarter average, likely indicating that estimates were too low.
The +8.1% earnings growth thus far in Q3 compares to +7.7% growth in Q2 and the 4-quarter average of +4.7%. The revenue growth performance is a weaker, with the current +3.4% growth rate modestly down from +3.7% in Q2 and the 4-quarter average of +4.4%. Unlike recent quarters, The Finance sector isn’t driving growth in Q3. Total earnings growth outside of Finance of +6.5% compares to no growth (0%) in Q2 and the average +0.2% growth in the preceding four quarters. Improved growth at the Technology, Basic Materials, Transportation, and Energy sectors accounts for the ex-Finance strength in Q3.
Total earnings for the 57.7% of the Technology sector’s market capitalization that have reported results already are up +10.8% from the same period last year, which compares to earnings declines of -7.6% in Q2 and the 4-quarter average of -1.5%.
At the medium industry level (or M level), we have 7 industries in the Technology sector, of which only Telecom Services hasn’t reported any results yet. The growth picture has improved for each of the other six industries, with the improvement particularly notable for the Software & Services and Semiconductor industries. These two industries combined account for 41% of the sector’s total earnings. The +21% total earnings growth at Google (GOOG) and +17.4% at Microsoft (MSFT) account for the positive growth profile of the Software & Services industry.
Total earnings for the Computer & Office Equipment industry, the biggest industry in the sector accounting for 43% of the sector’s total earnings, are up a much more modest +3.3% at this stage. Tough comparisons for Apple (AAPL) will push this industry into the negative and bring down the overall growth for the sector as a whole.
Total earnings for the Basic Materials sector are up +25.6% on +5.2% higher revenues. The improvement in the sector’s growth numbers is primarily a function of easy comparisons, particularly in the sector’s dominant chemicals industry (69% of total sector earnings come from the Chemicals & Fertilizer industry). Chemicals earnings are up +14.1% at this stage, largely due to easy comparisons at Dow Chemicals (DOW). Dow missed and guided lower, but its Q3 total earnings were up +37.6% year over year.
The Composite Growth Picture
Total earnings for the S&P 500 as a whole, combining the results from the 244 that have reported with estimates for the remaining for the 256, is for growth of +3.2% on +1.3% higher revenues. This compares to +3.4% earnings growth in Q2 on flat revenues.
Only four sectors are expected to have double-digit earnings growth in Q3 – Finance (+11.4%), Construction (+28.8%), Transportation (+13.5%), and Business Services (+10.9%). Excluding Finance, total earnings for the S&P 500 are expected to be up +1.3% on +2.2% higher revenues, which is up from a decline of -2.4% in total earnings on +1.1% higher revenues in Q2. Given the trend we have seen thus far, actual earnings growth in Q3, when all reports are in, will most likely be better than what saw in the first two quarters of the year – likely in the +4% range.
Q4 Estimates Coming Down
Estimates for Q4 have started coming down, though they still have plenty of room to go before reaching ‘reasonable’ levels. The chart below shows consensus earnings growth rates for the next two quarters, the composite estimates for Q3 and the actual growth rates for the first two quarters of the year.
The current +8.9% earnings growth in Q4 is down from +9.5% last week and above +10% a few weeks back.
Part of the strong Q4 growth is a function of easier comparisons, as 2012 Q4 represents the lowest quarterly earnings total for the S&P 500 in the last six quarters, with the comps particularly easy for the Finance sector. But it’s not all due to easy comparisons, as the expected earnings totals for Q4 represent a new all-time quarterly record. Total earnings for the S&P 500 reached a new record at 0.3 billion in Q2, surpassing Q1’s 5.5 billion record. But they are expected to reach 9.1 billion in 2013 Q4, with total earnings growth outside of Finance expected at +4%.
The evolving outlook for Q4 is perhaps the most important aspect of the Q3 earnings season, more so than Q3 earnings/revenue growth rates and beat ratios. While the overall level of aggregate earnings is in record territory, there isn’t much growth. The longstanding hope in the market has been for earnings growth to eventually ramp up. But the starting point of this expected growth ramp-up keeps getting delayed quarter after quarter. The hope currently is that Q4 will be the starting point of such growth.
Guidance thus far in Q3 isn’t any different from what we have been seeing over the last few quarters. This means that estimates for Q4 will follow the negative revision pattern that we have been seeing repeatedly for more than a year now.
