With 94% of the companies in the S&P 500 having reported their earnings for the calendar year third quarter, investors have been able to assess and understand earnings trends for companies but also the market as a whole. To review, “earnings season” is typically a four-to-five-week period every three months where companies give investors a glimpse into the current health of the company and a sense of how their business is progressing. Major financial banks, such as Bank of America (BAC) and JPMorgan Chase (JPM), are typically the first to report while major retailers, such as Walmart (WMT) and Target (TGT), are among the last. Earnings reports provide investors with data and commentary from the company on performance, but also allow for the adjustment (and sometimes reset) of expectations of future growth based on current and projected trends.
In aggregate, third quarter earnings reports have come in better than expected.1
- 82% of companies in the S&P 500 have reported earnings per share (EPS) above expectations (a “beat”).
- Earnings “beats” were higher than the five- and 10-year averages of 77% and 74%, respectively.
- Revenue performance was a bit more muted as only 62% of companies reported higher sales than expected.
- Revenue “beats” were below both the five- and 10-year averages.
When companies report earnings, stock prices generally react positively to above expectation earnings reports (“beats”) and negatively to reports that fall below estimates (“misses”). The chart below1 shows the average reaction in the third quarter compared to the five-year average. It shows that positive reactions were slightly higher but negative reactions were far worse than the average. Short-term reactions to company earnings, however, shouldn’t be considered a perfect measure of actual company performance. Short-term reactions can be highly influenced by other factors such as economic data, market sentiment, and even just trading activity.
Furthermore, different sectors of the market can often have wildly diverging growth based on economic activity and favorable or unfavorable conditions for their specific segments. In the third quarter, Communication Services, Consumer Discretionary and Financials posted the highest positive earnings growth while Energy, Materials, and Health Care saw the greatest decline.1
Interestingly, the number of companies citing recession and inflation in their earnings reports or calls has declined quite dramatically from last year. The left chart below shows the number of companies discussing recessions and the right chart shows the number of companies discussing inflation.
Additionally, companies often give projections for the following quarter or fiscal year–often referred to as guidance. In the third quarter, 96 companies issued earnings guidance for the fourth quarter:1
- 64 of those companies issued guidance below expectations.
- This is higher than average, which could signal a potential slowdown in the level of business and consumer activity.
It is important, however, to remember that companies tend to take the conservative approach to guidance and stick to the mantra of “under promise and over deliver.” Investors need to keep a balance between what the company says and what their potential earnings power could be given a number of other factors.
At Gradient Investments, we focus on business fundamentals. In that regard, earnings season is an important time to assess the current snapshot of the company but also determine whether the future course aligns with our thinking on the company. Performance, especially in the short term, can be highly influenced by external factors and isn’t a perfect barometer for actual company health. Over the long term, however, stock prices tend to follow earnings growth. Our philosophy is relatively simple: buy good companies that are meeting or exceeding expectations and are trading at discount prices to what we believe is their actual value. Earnings season helps us make those determinations and also keeps us informed of any change in direction that may cause us to reevaluate our holdings.
Posted here on November 21, 2023 by Tyler Ellegard, CFA®