EmailA handful of companies still need to report their results, yet the third quarter earnings reporting period is essentially over.
In brief, the earnings results were better than expected. That doesn't mean, however, that they were good.
Just as important, guidance for the fourth quarter left a lot to be desired.
One Good Exclusion Deserves Another
According to FactSet, the third quarter blended earnings growth rate was -3.1% on September 30. Today it is -0.9%.
That is the basis for saying the reporting period was better than expected. However, the 0.9% decline in earnings, and the understanding that third quarter revenue declined 1.2%, is also the basis for saying the results in aggregate were not good.
Much of the blame for the earnings decline can be placed on the Energy sector, which experienced a 17.7% decline in third quarter earnings. If it is excluded, FactSet notes the growth rate for the third quarter would improve to 2.3%.
Conversely, the Financials sector, which reported 11.8% growth, is the main reason why the third quarter blended growth rate wasn't worse. If the Financials sector is excluded, the growth rate for the third quarter would fall to -3.2%.
In the end, it all counts.
An earnings and revenue growth summary for each sector is provided in the table below.
| Sector | Q3 Earnings Growth | Q3 Revenue Growth |
|---|---|---|
| Consumer Discretionary | 3.8% | 2.8% |
| Consumer Staples | 1.3% | 1.2% |
| Energy | -17.7% | -17.1% |
| Financials | 11.8% | 2.6% |
| Health Care | -0.7% | 5.2% |
| Industrials | 4.0% | 1.1% |
| Information Technology | 1.2% | 3.2% |
| Materials | -23.6% | -6.4% |
| Telecom Services | 0.8% | 2.8% |
| Utilities | -1.7% | 0.1% |
| S&P 500 | -0.9% | -1.2% |
Additional earnings insight from Thomson Reuters indicates that 64% of the S&P 500 companies reporting earnings beat expectations while 11% were in-line and 25% fell short of expectations. In a typical quarter dating back to 1994, 62% of companies beat estimates, 17% match, and 21% miss estimates, according to Thomson Reuters.
Lowering the Bar
In terms of negative surprises, they were concentrated on the top-line and in the earnings guidance for the fourth quarter.
Just 41% of S&P 500 companies reporting revenues exceeded expectations. According to FactSet, that is the lowest percentage of companies surpassing expectations since the first quarter of 2009.
The lackluster revenue growth (-1.2%) is perhaps the most underappreciated aspect of the third quarter reporting period. It shows that demand is weak and it indicates that earnings growth will be hard to come by if companies can't expand profit margins that are already near record high levels.
Plenty of companies sounded an earnings warning, too. Out of the 103 companies issuing fourth quarter guidance, 73% issued negative EPS guidance, which is well above the long-term average of 61%.
The disproportionate number of warnings prompted analysts to lower their estimates.
Fourth quarter earnings growth is now projected to be 3.9% versus 9.3% at the end of September. Earnings growth estimates for the first quarter have been cut to 3.1% from 5.3%.
The downward revision to growth estimates is not a surprise to us. We said in our October 8 preview that we expected growth estimates to come down as the reporting period unfolded given the weak macroeconomic conditions and the uncertainty regarding the presidential election and the fiscal cliff.
| Sector | Q4 Earnings Growth | Q4 Revenue Growth |
|---|---|---|
| Consumer Discretionary | 5.8% | 4.7% |
| Consumer Staples | 3.2% | 2.7% |
| Energy | 3.5% | -8.2% |
| Financials | 21.6% | 7.0% |
| Health Care | -0.9% | 6.8% |
| Industrials | -4.3% | 1.3% |
| Information Technology | -2.3% | 5.5% |
| Materials | 6.5% | -0.7% |
| Telecom Services | 14.1% | 1.7% |
| Utilities | 6.6% | 11.3% |
| S&P 500 | 3.9% | 2.5% |
2013 Earnings Glass Still Half Full
The election uncertainty is over, but the fiscal cliff uncertainty is as high as ever. That uncertainty coupled with the stronger dollar, Europe's problems, and the slowdown in emerging markets were oft-cited explanations for disappointing guidance.
Notably, the growth estimate for calendar year 2013 hasn't changed much. It stood at 11% at the end of September, and today it is 10%.
With projections for just 3% earnings growth in the first quarter, analysts are clearly expecting things to ramp up as 2013 unfolds.
Something else is also apparent in the table below. Considering earnings growth is expected to outpace revenue growth in every sector except the Utilities sector, analysts must either be expecting strong profit margin expansion and/or strong share buyback activity.
| Sector | CY13 Earnings Growth | CY13 Revenue Growth |
|---|---|---|
| Consumer Discretionary | 13.6% | 5.5% |
| Consumer Staples | 8.9% | 4.6% |
| Energy | 4.9% | -2.8% |
| Financials | 14.1% | 3.3% |
| Health Care | 6.8% | 4.4% |
| Industrials | 9.0% | 4.4% |
| Information Technology | 9.1% | 6.8% |
| Materials | 20.7% | 4.9% |
| Telecom Services | 20.6% | 1.8% |
| Utilities | 1.8% | 5.3% |
| S&P 500 | 9.9% | 3.5% |
At this point, we would argue that earnings growth estimates for CY13 are overly-optimistic given the ongoing struggles in Japan and the eurozone, and the drag that the fiscal cliff -- compromise or not -- will have on the U.S. economy.
Our economic outlook calls for muted growth in the first half of 2013 and a return toward a weak 2.0% growth rate in the back half of the year.
What It All Means
The third quarter earnings reporting period came and went, largely overshadowed by the intrigue surrounding the presidential election and the fiscal cliff.
The earnings results themselves ended up being better than expected, yet that isn't saying much when better than expected equates to no growth.
Although estimates for the fourth quarter have been chopped down from silly heights, the double-digit growth estimate for calendar year 2013 is asking a lot when the eurozone and Japanese economies will be barely growing, if they are growing at all, and when the U.S. economy will be fortunate to grow 2.5% even with a compromise on the fiscal cliff.
While there might be a relief rally on word of a fiscal cliff compromise, bear in mind that the revision risk for earnings growth will remain to the downside.
Double-digit earnings growth expectations just don't mesh with the weak growth outlook for most of the world's largest economies.
That is a reality and a risk factor that should not be forgotten when the headline hoopla prompts the market to take leave of its fundamental senses.
--Patrick J. O'Hare, Briefing.com
