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DC Worries & the Q3 Earnings Season - Earnings Outlook

Posted: 10/9/2013 5:19:00 AM
Referenced Stocks: ADBE;DRI;FDO;JPM;WFC

The following excerpt is from this week's Earnings Trends.  To see the full report, please click here .

DC Worries & the Q3 Earnings Season

The earnings season has gotten underway, but investors remain justifiably distracted by the partisan budget battle in Washington D.C. And with the debt ceiling deadline fast approaching, the issue is becoming more than a mere side-show. Let's hope that the political leadership doesn't do any more damage and let investors get on with the earnings season without worrying about headlines coming out of DC.

The earnings season has gotten underway, though it doesn't really ramp up till next week when more than 70 S&P 500 members will be reporting results. This busy line-up of 2013 Q3 earnings reports and the debt-ceiling deadline next week may not mix that smoothly.  

It is too early to draw any firm conclusions from the 27 S&P 500 companies that have reported results already (as of Wednesday afternoon - October 9th), but the earnings and revenue growth rates for these companies are tracking better than what we saw over the last few quarters while the beat ratios are a bit on the weak side. We will have a much better sense of this earnings season by the end of next week as by then we will have seen results from more than 1/5th of S&P's total membership.

The real Q3 earnings story is not about the 27 companies that have reported already, but the remaining 473 companies. And it's actually more about the evolving outlook for Q4 than what happened in Q3, as consensus expectations are for a strong growth rebound in the last quarter of the year.

Estimates for Q3 came down sharply as the quarter unfolded, a trend similar to what has been playing out repeatedly over the last few quarters. The current consensus earnings growth rate for the quarter of +0.5% is down from +1.1% last week and +5.1% in early July.  Each of the 16 Zacks sectors suffered negative estimate revisions in that time period, with the highest revisions in Basic Materials, Retail, Energy, and Technology. Aerospace and Consumer Discretionary held up relatively better, with both sectors experiencing the least amount of negative revisions.  

The low expectations for Q3 effectively guarantee that most companies will have little difficulty in beating them. We see this quarter after quarter, with about two-third of the companies beating earnings expectations - a good illustration of management teams' tendency to under-promise and over-deliver.

But unlike the low growth expectations for Q3, consensus estimates for Q4 and beyond represent a material acceleration in the growth pace. Total earnings growth is expected to ramp up to +10.2% in Q4 from the roughly +3.1% growth pace in the first half of the year and the current expected +0.5% growth in Q3. The actual growth in Q3 will likely be more in the vicinity of what was achieved in the first half of the year, i.e. in the +2.5% to +3% range.

Guidance has overwhelmingly been negative over the last few quarters. But if current Q4 expectations have to hold, then we will need to see a change on the guidance front; we need to see more companies either guide higher or reaffirm current consensus expectations. The overall tone of guidance thus far in Q3 isn't materially different from what we have been seeing in the last few quarters, as the negative guidance from Yum Brands ( YUM ), Family Dollar ( FDO ), Adobe ( ADBE ), and Darden ( DRI ) shows. We will know more in the next three weeks, but Q4 estimates remain at risk of significant revisions in the absence of reassuring company guidance.

The market hasn't cared much in the recent past about negative revisions as aggregate earnings estimates have been coming down for over a year now. But if we are entering a post-QE world, as I believe we are, then it will likely be difficult to overlook negative earnings estimate revisions going forward. How the market responds to negative guidance and the resulting negative revisions will tell us a lot about what to expect going forward.

Key Points

To see the full Earnings Trends PDF, please click here .

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