Monday, August 19, 2013

Q2 Earnings: Factoids and Takeaways

With Q2 earnings season almost complete, it's worth looking at some of the results and considering market implications.  The tweet below from FactSet is chock full of charts that slice and dice the earnings, revenue and guidance data.  
In addition, this link to S&Ps "Lookout Report" has their version of the earnings analysis.  (Note that they appear to use different methodologies in calculating the data.  Sometimes that's due to a focus on different levels of the earnings reports such as 'operating' vs 'net', and sometimes it's due to the year-over-year comparison of companies in the S&P, some being there today but not a year ago, and vice versa. There might also be some other accounting details that differ, but in general, many themes resonate from both reports).

Below are a mixture of factoids and personal takeaways regarding the S&P 500 companies who have reported so far, in no particular order:
  • Roughly 70% have beat earnings estimates.
  • Roughly 50% have beat revenue estimates.
  • Cynics might say (me included) that 'estimates' had already been lowered so much that the bar to beat was already quite low, so 'beating' is not such a great feat.
  • Non-cynics would have to admit that despite the 'beats', the picture seems clear that revenue growth is underwhelming and according to S&P with regard to revenue growth rate, it is 
"currently still in negative territory at -0.56%, which would be the first negative revenue growth rate we've seen since third quarter 2009"
  • Earnings, therefore, seem to be benefiting from continued cost-cutting and increasingly lean & mean operating leverage.
  • How about the forecast for Q3?  Good question.  FactSet's data shows roughly 80% of the companies that have proffered forward guidance were negative, 20% positive.  S&P's take is somewhat different: they have roughly 60% negative, 20% positive, the rest in line.  Either way, it appears that there's agreement on the fact that more companies have reported negative guidance for Q3 by a wide margin over those who've reported positive guidance.  
  • Interestingly, S&P notes that the ratio of negative to positive is lower than it's been for some time, which they view as good news for Q3 earnings!  To quote S&P: 
This produces a negative-to-positive ratio of 2.3, meaning that for every two or so companies that have issued negative guidance, one has issued positive guidance. This is below the historical average of 2.4, and much lower than the trailing four-quarter average of 3.6, a positive sign for future earnings performance. The last time the warning ratio was this low was in first quarter 2012.
  • My takeaway, however, is not as sanguine.  While the second half of 2013  is seen by many companies and analysts as being better than the first half, it's still apparent that earnings outlooks suggest significant headwinds to earnings growth!  Despite this, however, keep in mind, that until recent days of stock market sell-offs, which btw were largely led by 'tapering' fears of less central bank stimulus and in turn, higher rates, most stock market averages in the US were hitting new record highs!
  • Finally, forward EPS and P/E estimates appear to be at higher levels than such estimates have been historically.  This would suggest that analysts are still quite optimistic about the second half of the year. The FactSet charts (on page 16 of their report) show them to be only slightly above longer term averages, not a levels that are even close to historical high points!  Furthermore, the FactSet charts on page 17 show that trailing 12-month P/Es are actually in line with 10-yr average levels (roughly 15.7) and not at levels in the higher teens that existed just before prior stock market selloffs.  So based on these stats, many are arguing that stocks still have room to the upside.  This kind of thinking was articulated in the following piece by John Authers of The Financial Times along w/the follow-on commentary in which its noted that most indicators of equity valuations still show stocks to be fairly to cheaply priced with the exception of Shiller's cyclically adjusted P/E ratios.
  • Bottom line on earnings?  The overall message is far from euphoric.  Plenty of headwinds are lined up to challenge future earnings growth, yet optimism seems to abound for accelerating growth in the second half of 2013.  Is the tug of war between those dynamics playing out in recent market malaise? Or has recent equity market weakness not yet factored in potential earnings woes later in the year?  
  • As I've indicated in several recent posts and in our last Newsletter, I believe that markets are seemingly myopically focused on 'tapering', concluding that a lessening of the Fed's stimulus means immediate trouble for stocks.  That might be true over the longer term if we were to  have a protracted period of much higher interest rates, but the Fed has remained steadfast in its message that tapering will only start to occur once the economy is revving and running on its own power, without the need for all of the Fed's tail-winds.   A more convincing argument, in my mind, for being negative on stocks at this time would be to focus more on the relative gloom that has been expressed by a number of S&P 500 companies in their forward guidance.  Add to that the issues of Washington's upcoming negotiations on the debt ceiling, sequestration impacts, Middle East "Arab Winter", China's de-bubbling efforts, and Emerging Market countries forced into policy dilemmas as to whether to defend their currencies and fight inflation or to stimulate their economies, and you have a potential formula for a currently overly optimistic earnings valuation in equities.  Admittedly, recent equity market selloffs have re-priced some companies to levels that seems to be more realistic valuations, but on the whole, defensive portfolio positioning would still seem worthy of consideration.
Stay tuned for more....

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