Third Quarter Earnings Season

November 4th, 2022

Over the last few weeks, the third quarter earnings season shifted into high gear with some of the largest companies in the S&P 500 reporting results. Of the 429 S&P 500 companies that have reported so far, roughly 56 percent have beaten revenue forecasts and about 70 percent have surpassed earnings expectations. According to Bloomberg data, revenue growth is trending around 10.73 percent and earnings are up 3.17 percent thus far. In aggregate, sales have surpassed analyst estimates by 1.27 percent and earnings by 3.07 percent. Since earnings season began on October 7th, the S&P 500 is up 2.18 percent.

S&P 500 Third Quarter Revenue & Earnings Surprise & Growth

While the results look good on the surface, expectations for third quarter earnings growth had already come down from 11 percent during the summer to 3 percent just before the reporting season started. So, the bar was set low. Furthermore, earnings growth this quarter is actually down 3.5 percent when excluding the energy sector. That’s after a 1.8 percent drop in the previous quarter, setting up the first consecutive decline since 2020. While earnings for US energy companies have grown strongly due to higher oil prices as the uncertainty surrounding global supply grows, the rest of the market is contending with elevated inflation and interest rates, a strong dollar, and slowing demand.

So far, companies have been able to meet EPS targets in the third quarter, however operating margins are falling short of expectations. Operating margins for the S&P 500 (excluding financials and real estate) are on track to hit 15.5 percent vs. the forecast of 16.3 percent before the quarter started. Excluding energy, operating margins are set to come in around 15.1 percent vs. estimates of 15.8 percent. Bloomberg data suggests that almost half of S&P 500 companies have missed operating margin estimates, indicating that companies may be having a hard time containing costs. Since reporting began earlier in October, analysts have reacted to operating margin misses by lowering expectations for the coming quarters.

Furthermore, S&P 500 earnings estimates continued to decline through the third quarter. Consensus expectations are calling for EPS growth of 8.2 percent in the current year, 3.7 percent in 2023, followed by a reacceleration to 9.5 percent in 2024. It should be noted that earnings for energy companies are expected to turn negative next year after a strong showing in 2022, so the forecast for positive earnings growth in 2023 may be too optimistic.

Despite the market's rally since reporting started, Bloomberg data shows companies that have missed expectations are getting punished more severely than in the past. For the companies that have reported, the average one-day excess return for stocks of companies that beat EPS estimates is 0.8 percent. For the companies that beat both revenue and earnings expectations, the one-day excess return was 1.5 percent. The companies that fell short of earnings estimates witnessed an average excess price return of -4.3 while those that missed both sales and earnings got hit with a -7.8 percent excess return.

We are still concerned that much of the stock markets’ decline year to date reflects higher interest rates and does not yet reflect the true earnings impact of a global economic slowdown. As noted above, analysts are still forecasting earnings growth of nearly 4 percent in 2023, which would not be consistent with a recession. Recall that earnings growth typically declines 20-30 percent during a recession, so it seems analysts are not including this risk in their forecasts. At Private Asset Management, we continue to prefer defensive equities as the Fed remains steadfast in tightening monetary policy despite a slowing economy. 

Alex Dietz

Senior Research Analyst

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