Investors who are wondering why stocks haven’t rallied this earnings season need look no further than the actual data. This earnings season is shaping up to be truly spectacular in terms of expectations, but a look under the hood shows that earnings are less than spectacular. While bottom line growth continues to be robust, the top line growth continues to come in weak (although better than expected). Not surprisingly, this is in-line with what we have been seeing in segments of the real economy (see “No Recovery On Main Street” for more info).
Earnings season is over half way over and the analysts have never been more wrong. Thus far, 74% firms have exceeded expectations while just 19% have fallen shy of expectations. Of course, it’s not unusual for firms to outperform the analysts expectations, but this ratio of 6:1 is practically unheard of. Zacks investment research notes that the average earnings season sees a ratio of 3:1 which means this earnings season is twice as good as those of the past. Not only that, but firms are also beating by a much wider margin than normal. On average, firms beat by 3%, but are beating by 7.5% this earnings season.
Of the firms reporting 72% have outperformed in terms of operating income while only 43% of them have reported earnings that were higher than the same quarter last year. On the top line, 64% of firms have outperformed this quarter’s revenue estimates while just 27% of firms are reporting higher revenues than the same quarter a year ago. Margins are coming in at 7.8% vs the 15 year average of 6.6%. This shows that margin expansion and cost cutting is leading to much of the bottom line growth.
The discrepancy between expectations and reality is nowhere more apparent than it has been in our expectation ratio. The ratio clearly shows the schism between actual earnings and analysts expectations. The ratio was essentially flat this week versus last week’s reading, but continues to display a very wide margin between analysts estimates and the underlying income statement components of the ratio. We would expect the ratio to narrow in the coming quarters as analysts ratchet up their estimates and narrow the divide. (See here for more on the ER).
Overall, earnings are expected to decline 5% for the S&P 500 on a year over year basis. Total sales are expected to decline 11% year over year and slightly higher compared to Q2. Some might call this an L-shaped recovery in revenues, but the slight uptick actually represents more of a backwards check mark. While cost cutting and margin expansion have helped contribute to the U-shaped EPS recovery, the true underlying weakness of the economy is apparent on the revenue line.
(Revenues Figures Are In $Millions)
The headline numbers for this earnings season will be paraded as a huge success by the mainstream media, but a look under the hood shows no year over year improvement in the top line growth and no sustained bottom line growth can occur without a follow-through in top line growth. For now, the verdict is still out on the recovery in corporate earnings, but the backwards check mark shaped recovery in revenues is quite apparent.
Source: Zacks, S&P
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.