Three Takeaways from the Q1 Earnings Season

With results from more than 77% of S&P 500 members already out and another 60 on deck to report this week, the bulk of the reporting cycle is now behind us. Here are the three trends that are clearly visible this earnings season

First, the growth challenge is very real. This is no surprise and has been well known for a while now, giving rise to the so-called ‘earnings recession’ narrative. Regular readers know our views about the so-called ‘earnings recession’ narrative this year. For reference, check out >>>> Earnings Recession Fears Are Exaggerated

For the 388 S&P 500 members that reported results through Friday, May 3rd, total earnings growth is at +1% on +4.2% higher revenues. Total earnings and revenues were up +15.2% and +6.4% for the same group of 388 companies in the preceding quarter, respectively.

The comparison chart below puts the earnings and revenue growth pace for these 388 index members in historical context.



This tough comparison on the growth front is due to the tax-cut boost to corporate profitability in 2018. The growth picture is expected to start improving in the second half of the year and accelerating into next year, with full-year 2020 earnings growth for the index reaching double digits after a less than +2% growth in 2019.

The moderation in this year’s growth also reflects the deceleration in global economic growth. The global GDP growth picture appears to have stabilized and even started improving in China and some other parts, but the pace is nevertheless expected to be below what we experienced in the last two years. 

The bearish narrative is that we have reached the end of the economic cycle when growth inevitably turns south. Macroeconomic data doesn’t support this narrative currently, but these things are hard to decipher in real time anyway.

My reading of the economic tea leaves is a lot more favorable. While I acknowledge the weakness in Europe, the outlook for the U.S. economy continues to be positive, with growth modestly below the preceding year’s level, but still very stable. The stronger than expected Q1 GDP growth rate reconfirms this view, even though the elevated GDP growth reading benefited from a couple of ‘lower quality’ drivers. And other key regions of the world, particularly China, are showing signs of ‘green shoots’.

We will know either way as we move through the rest of this year, but my money is on continued growth.

Second, driving the earnings growth challenge is widespread margin pressures across all major sectors. While the pace of revenue growth has come down as well, but the top-line deceleration is a lot less pronounced than is the case with earnings.

Net margins for the 388 index members that have reported results are 12.8%, which compares to 13.2% for the same group of index members in the year-earlier period, as you can see in the comparison chart below.



A big reason for this margin issue is the tough comparisons to last year when margins got a big boost from the tax-cut legislation. But some cyclical factors are at play as well, with many companies on the earnings calls complaining about rising material, transportation and payroll costs.

Third, and most importantly, estimates for the current period (2019 Q2) have been coming down as companies have been reporting Q1 results and sharing their outlook for business trends.

Total Q2 earnings for the S&P 500 index are expected to be down -0.8% from the same period last year on +4.9% higher revenues, with the growth pace steadily coming down in recent days. That said, the pace and magnitude of negative revisions to Q2 estimates is lower than what we had been seeing at the comparable period in the preceding quarters.

The chart below shows the evolution of Q2 earnings growth expectations in recent weeks.



The Q1 reporting cycle still has some ways to go, with more 1100 companies reporting results this week, including 61 S&P 500 members. The notable companies reporting this week include the media operators like Disney (DIS), Fox Corp. (FOX), Viacom (VIA), travel operators like Booking (BKNG), TripAdvisor (TRIP) and a number of the major utility companies. It is reasonable to expect that estimates for Q2 will come down some more in the coming days.

Expectations for 2019 Q1 As a Whole

Looking at Q1 as a whole, combining the actual results that have come out from the 388 S&P 500 members with estimates for the still-to-come companies, total earnings for the are expected to be up +0.1% from the same period last year on +4.6% higher revenues.

Driving the expected Q1 earnings decline is broad-based margin pressures across all major sectors, with net margins for the index of 11.4% down from 11.9% in the year-earlier and preceding quarter. Net margins are expected to be below the year-earlier period for 9 of the 16 sectors, including the Technology sector (more on Tech margins below). 

The table below shows the summary picture for 2019 Q1, contrasted with what was actually achieved in the preceding period.



As you can see above, net margins for the index are expected to be 50 basis points below the year-earlier level, with margins notably weak in the all-important Technology sector, with 2019 Q1 net margins for 19.1% below the year-earlier period’s 21.2% level.

The chart below shows the sector’s Q1 net margins picture in the context of where margins have come from and where they are expected to go.



The chart below shows earnings and revenue growth expectations for 2019 Q1 (the blended growth picture) contrasted with what we had in the preceding four quarter and what is expected in the following three quarters.



Expectations for 2019 Q2 and the following quarters will evolve as companies report Q1 results and provide commentary about ground-level business conditions. We will be keeping a close eye on this revisions trend.

For an in-depth look at the overall earnings picture and expectations for Q1, please check out our weekly Earnings Trends report >>>>  Making Sense of Tech Sector Earnings

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