Q3 earnings are officially over and it was one for the record books. 75% of all firms beat earnings estimates while just 14% missed. Companies didn’t just beat earnings – they beat earnings by a wide margin. The average historical beat is just over 3% while firms beat by over 7% in Q3. This is a continuation of a trend we have been talking about ever since the Expectation Ratio reversed course earlier this year.
The analysts have been fantastically wrong about the earnings outlook and that trend looks like it is likely to continue. The latest reading on the ER shows another strong reading of 1.27, but a short-term downtrend. This is a clear sign that we have likely seen a peak in the divergence between analysts and reality. In other words, the analysts are catching up to reality. For now, however, the long-term trend remains positive and the ratio continues to forecast an environment of very low expectations and stronger than expected earnings.
Curiously, the real underlying organic growth in earnings has not been all that strong. Firms continue to beat on very strong margin expansion that is primarily based on cost cutting. Just 29% of all S%P firms reported year over year revenue improvement last quarter. Of course, Wall Street isn’t a world based in reality, but a world based on reality compared to expectations. Despite this organic weakness, expectations remain very depressed and as long as firms can overcome these low expectations the market is likely to remain buoyant.
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.