Let me start with this simple question. For those of you that have been following earnings of S&P 500 companies for the quarter ended Dec 31, 2022, do you feel positive or negative overall about what you are hearing, given we are about halfway through earnings season?
And before you answer that, let me give you a data point to digest. Since the S&P 500 companies kicked-off earnings around 2.5 weeks ago (starting Jan 20th), the S&P 500 is up 6.8%.[1] Does that influence your decision regarding the “quality” of earnings so far?
I recently had an exchange with a reader regarding the interpretation of the current round of earnings. As you might have read, the results so far have generally been interpreted as “better-than-expected”. Global economic data has also been gently tilted towards better-than-expected since the beginning of the year, and the Fed has been relatively benign although constantly trying to remind investors that it remains hawkish. It is difficult to give the Fed and economic data credit for the full 6.8% increase in the S&P 500, so it suggests that a portion – perhaps a good portion – of the uplift might be attributable to better-than-expected corporate earnings. Here’s what two prominent data companies say that track earnings results:
"Of the 250 companies in the S&P 500 that have reported earnings to date for 22Q4, 69.6% have reported earnings above analyst estimates. This compares to a long-term average of 66.3% and prior four quarter average of 75.5%. 65.2% of companies have reported 4Q22 revenue above analyst expectations. This compares to a long-term average of 62.0% and an average over the past four quarters of 72.8%.” – I/B/E/S data from Refinitiv, Feb 3, 2023
“For 4Q 2022 (with 50% of S&P 500 companies reporting actual results), 70% of S&P 500 companies have reported a positive EPS surprise and 61% of S&P 500 companies have reported a positive revenue surprise.” – Earnings Insight from Factset, Feb 3, 2023
On a pure numerical basis, it is true that earnings have generally been slightly better than consensus analysts’ expectations so far, as both Refinitiv and FactSet have reported. However, this simplistic view does not take account of things like the relevancy (i.e. size / profile) of the reporting companies or the magnitude of the various “beats” and “misses” (meaning percentage above or below analysts’ estimates).
I do not think I am alone in feeling that – in spite of the empirical data – earnings have felt somewhat disappointing. There are three reasons that I feel this way.
1. Some of the most visible and influential misses have come from large-cap and well-known companies, like Apple, Alphabet (Google) and Meta Platforms (Facebook). Of the 10 largest companies in the S&P 500 index (27.2% of the index by market cap on Feb 6th), eight have reported earnings and two (NVDA and BRK) have not. Of the eight companies that have reported their most recent quarterly results, three have missed bottom line earnings and six have missed top-line revenues.
Therefore, earnings and revenue “misses” feel skewed towards larger companies which have more geographic scope and arguably broader business reach. In other words, the results of these larger, more prominent companies should matter more for a variety of reasons than those of smaller, less geographically diverse and less-economically sensitive companies, for example. One thing is apparent though –earnings and revenue misses have been most pronounced in the tech sector.
2. Even though earnings are viewed to be slightly better than analysts’ consensus expectations for 4Q22, quarterly earnings have declined (as expected) vis-à-vis 3Q22 earnings. FactSet has reported that the QoQ decline so far is 5.3% (4Q22 vs 3Q22). The “direction of travel” is very important, and the direction in this case is clear even if it was only begrudgingly anticipated by the analyst community. In addition to lower earnings QoQ, earnings “beats” have been lower so far in 4Q22 than in 3Q22. The graph below from FactSet and Morgan Stanley Research highlights the negative trend in earnings from quarter to quarter on a YoY basis since 4Q2013 (noting that the YoY basis removes seasonality as a factor).
3. Guidance has been poor from many companies. Some management teams have been soft in this respect in their discussions with investors following earnings releases, and others have been more definitive in formally revising guidance down. Refinitiv notes that 31 companies have revised 1Q23 earnings down so far, and six have revised earnings up. As you can see in the graph below from FactSet and Morgan Stanley Research, the trend is clearly going in the wrong direction.
In spite of this data (or perhaps because of it, meaning “the glass is half full”), the market has clearly ripped. In fact, some companies with disappointing earnings have taken steps to offset the share price pain that investors might have otherwise felt from lacklustre or below-expectations earnings by doing one of two things (or both, e.g. META).
Headcount reductions – The tech sector has quite rightly led the pack as far as announcing headcount reductions to reduce their cost base and offset margin pressure, hoping to improve their performance in the coming quarters off of what might be lower revenues. Of course, the challenge that layoffs do not address is declining (or less robust) revenue growth, largely a factor of market forces. Companies that have announced layoffs are not just tech companies, either. Layoffs have been announced by the likes of AMZN, GOOG, META, SPOT, PYPL, DELL, IBM, GS, FDX, ZM, BLK, MCD, EBAY, MMM and DOW, to name a few. Many other companies have announced job pauses, too, in order to combat slowing growth.
Stock buybacks – Other companies have announced rather sizeable stock buybacks, which investors have cheered. META is an example, which on its post-earnings call last week announced that it would increase its stock buyback authorisation by $40 billion. Many other tech companies, like AAPL and MSFT, have running buyback programmes. And to be fair, many companies which have done exceedingly well this round of earnings are also announcing stock buybacks, providing further rocket fuel for their shares.
I suppose how an investor feels about earnings is a subjective call. Based on the sharp increase in share prices, I am certainly in the minority casting doubts on this round of earnings. For whatever reasons – and there are more than just earnings – it still feels like risk markets have advanced “too far, too fast”, as momentum investors seize the moment and push share prices even higher. What is absolutely critical is that the foundation of these increases eventually falls into place.
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[1] Using close of S&P 500 on Jan 19th of 3,898.85 and close on Feb 7th of 4,164.