Q1 Earnings: A Case of Low Expectations
The following is an excerpt from this week's Earnings Trends piece. To access the full article, please click here .
The bulk of the Q1 earnings season is now behind us, with results from 374 S&P 500 members or almost 75% of the index's total membership already out. As we have been pointing out since the start of this earnings season, growth remains nonexistent, but the actual results are turning out to be less bad relative to the low levels to which estimates had fallen ahead of this reporting cycle. More companies are coming out with positive surprises for both earnings as well as revenues.
Importantly, while estimates for the current period (2016 Q2) have started coming down, they are not falling by as much as was the case at the comparable stage in the prior earnings season. Low expectations likely explain the deceleration in the negative revisions pace for Q2 as estimates for this period had already come down over the last four months. The recent favorable movement in the U.S. dollar's exchange value is likely helping matters on the margin as well.
Total earnings for the 374 S&P 500 members that have reported results are down -7.5% from the same period last year on -1.9% lower revenues, with 71.4% beating EPS estimates and 56.4% coming ahead of top-line expectations. The side-by-side charts below compare the results thus far with what we have seen from the same group of 374 S&P 500 members in other recent periods.
The left-hand side chart compares the Q1 earnings and revenue growth rates while the right side chart compares the percentage of companies coming out with positive earnings and revenue surprises. As you can see, the growth pace is notably weaker relative to the 4-quarter and 12-quarter averages, but positive surprises are tracking above historical periods for the same group of companies.
The recent decline in the exchange value of the U.S. dollar is helping S&P 500 members on the margin as well, but this preponderance of positive surprises is primarily a function of low expectations. The chart below shows the proportion of the 374 index members that have beat both EPS and revenue estimates. Even on this metric, positive surprises are more numerous relative to historical periods.
The expectations angle is helpful in making sense of the market's disappointment with the Tech sector results - the impact of earnings announcements on stock prices is the most notable for this sector, with the average one-day negative stock price reaction the most for the Tech sector. We see this reaction across the board in the sector, but is notable from Google's parent Alphabet ( GOOGL ), Apple ( AAPL ), Microsoft ( MSFT ) and others. These companies, particularly Google and Microsoft failed to rise to the expectations that had built up following their blowout results the prior earnings season. In other words, the Tech disappointments are inverse of what is happening this earnings season in most other sectors, with low expectations providing easy-to-beat hurdle rates for most companies.
The blended growth picture for Q1, combining the actual results from the 374 that have reported with estimates for the still-to-come 126 index members, shows total earnings declining -7.1% from the same period last year on -1.1% lower revenues. This would be the 4th quarter in a row of earnings declines for the index.
Estimates for the current period (2016 Q2) show these declines continuing, with total earnings for the S&P 500 index expected to be down -5.5% from the same period last year -1.0% lower revenues. Q2 estimates have been coming down in recent days, but the magnitude of negative revisions is lower relative to what we experienced in the comparable period in the 2015 Q4 earnings season.
The chart below shows Q1 growth expectations contrasted with what was actually achieved in the preceding three quarters and estimates for the following four periods. As you can see in the chart below, all of this year's growth is dependent on estimates for the back-half of the year.
Many see the Q1 earnings season as the inflection point for corporate earnings, with the growth picture starting improve from Q2 onwards and turning positive in the back half of the year. The relative more numerous positive surprises and the fewer negative revisions to current-period estimates would support that view. But the proof of this narrative will become clear in the coming days as more companies report Q1 results and provide color on the evolving business picture.
To access the full Earnings Trends article, please click here .
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