Revenue Weakness Not Just a Large-Cap Issue

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The following is an excerpt from this week's Earnings Trends piece. To access the full article, please click here .

With results from more than two-thirds of the S&P 500 members already on the books, we have a good sense of how the Q3 earnings season has unfolded. The overall growth picture remains challenged, with companies struggling to beat lowered top-line expectations and estimates for the current period are coming down at an accelerated pace.

At this stage in the reporting cycle, the ratio of companies beating revenue estimates is the lowest that we have seen in the recent past. And this issue of weak revenue surprises is as present in the small-cap universe as it is in the large-cap world.

The revenue weakness notwithstanding, some pockets of strength have come up. The Tech sector has surprised with stronger results, with Q3 numbers from the sector not only coming in better relative to pre-season expectations, but also relative to sector's performance in other recent periods. The comparisons to other recent periods for the sector remain favorable even when looked at an ex- Apple ( AAPL ) basis.

Tech aside, the Medical sector has done reasonably well as well and early reports from the Retail sector are also encouraging. We should point out, however, that the bulk of the early Retail sector reports are weighted towards the online operators and restaurant companies, with results from the traditional retailers still awaited.

All in all, the picture emerging from the Q3 earnings season is one of weakness, particularly on the revenues side.

Q3 Scorecard for the S&P 500 ( as of November 4th, 2015 )

Including this morning's reports, we now have Q3 results from 403 S&P 500 members that combined account for 83.4% of the index's total market capitalization. Total earnings for these 403 companies are down -1.7% on -4.8% lower revenues, with 69.3% beating EPS estimates and only 40.3% coming ahead of top-line expectations.

Excluding Energy, total earnings for the rest of the index members that have reported would be up +5.2% on +1.1% higher revenues.

The chart below compares the growth rates and beat ratios for these 403 companies with what this same group of companies reported in other recent quarters.

Any way you look at it, this is weak performance from these 403 index members relative to what we have seen from this same cohort in other recent periods. Please note that the earnings growth rate (-1.7%) is actually even lower once the easy comparisons at Bank of America ( BAC ) are taken into account.

The top-line weakness is particularly notable, both with respect to growth rate as well as beat ratios. The fact that revenue growth is this weak isn't that much surprising given the macro headwinds. But the fact that so few companies have been able to beat the lowered top-line estimates has been a big disappointment.

Looking at Q3 as a whole, combining the actual results from the 403 S&P 500 members with estimates for the still-to-come 97 index members, total earnings for the index are expected to be down -2.4% from the same period last year on -3.8% decline in revenues. This would follow the -2.1% decline in earnings on -5.5% lower revenues in the preceding quarter. Excluding Energy, total earnings for the S&P 500 index would be up +4.3% in Q3 on +1.3% higher revenues.

Q3 Scorecard for Russell 2000 ( as of November 4, 2015 )

Please note that the top-line weakness this earnings season isn't restricted to multinationals in the large-cap S&P 500 index. The relative domestic oriented small-cap members of the Russell 2000 index aren't doing any better either.

For the Russell 2000 index, we currently have Q3 results from 1072 members that combined account for 60.6% of its total market cap (the index currently has 1979 members). Total earnings for these 1072 index members are down -5.1% from the same period last year on +1.7% higher revenues, with 52.5% beating EPS estimates and only 37.6% beating revenue estimates. This is weaker performance than we have seen from same group of 1072 index members in other recent periods, as the charts below show.

As you can see in the right-hand side chart above, the revenue beat ratio (37.6%) for the Russell 2000 index is notably below what we have been seeing from this same group of index members in other recent periods. In other words, the revenue weakness isn't solely a problem restricted to the multi-nationals as a result of the dollar strength, but is very much present in the small-cap space as well.

2015 Q4 Estimates

Estimates for the current period are coming down at an accelerated pace, with total Q4 earnings for the S&P 500 index now expected to be down -5.7% from the same period last year, which is down from an expected decline of -4.8% three weeks back. The magnitude of negative revisions to Q4 earnings estimates is greater than what we saw in the comparable periods for the preceding two quarters.

The chart below shows current Zacks consensus earnings growth expectations for the coming 4 quarters as well as the same for 2015 Q3 (shaded orange) and the actual growth achieved in the first two quarters of the year. As you can see, this year's growth has effectively evaporated, with growth momentum expected to pick up in 2016 Q2 and accelerate in the following quarters.

Part of the stronger looking growth in the second half of 2016 reflects an end to the Energy sector's drag due to easier comparisons for that sector. But hopes remain high for actual growth as well, particularly from the Finance and some of the economically sensitive sectors. It is reasonable to be skeptical of next year's optimistic looking expectations given how the 2015 estimates evaporated in front of our eyes over the last two quarters. May be it will be different this time, but judging from what we have heard from management teams on the Q3 earnings calls in recent days, it is more than reasonable not to buy into these estimates.

To access the full Earnings Trends article, please click here .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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