Last week was the busiest week in earnings season. Most of the trends that we’ve been seeing continued. It is shaping up to be a great quarter. The details of the reports give us information about what to expect in the next few quarters. Forward earnings expectations are what will drive stocks, so it’s critical to understand the scenario we’re in. Before I get into the details of the overall numbers, let’s look at how earnings have effected stocks so far this earnings season. The chart below is interesting as stocks have fallen on average when they beat, met, or missed earnings estimates. Obviously, the big difference from the average is that those beating estimates have underperformed the 5-year average by 1.5%.
The reason for this might be that firms beat analysts’ expectations, but missed the whisper numbers. The whisper numbers are the real expectations that investors have. You can check the whisper numbers for individual firms on a few websites. Another way to tell is what the stock does leading up to the report. If it falls big, a miss is being priced in and vice versa. Many times skeptical investors fear insider trading when a stock goes up before a beat and falls before a miss, but most of the time the stock is pricing in the whisper number.
The expectations heading into this earnings season were optimistic which explains the lack of upward moves after beats. One takeaway from this chart is that doesn’t imply stocks are undervalued. Some investors might take a quick glance at this and say that stocks aren’t reflecting the good news that has been reported. However, those investors are missing the past few weeks of great stock performance which priced in this great earnings season. The second takeaway is that the stocks which have missed estimates and didn’t fall that much might be the energy stocks. 7 of the 55 earnings misses where from energy stocks. These stocks already fell with oil prices. Everyone knew that it wouldn’t be a great quarter for energy compared to estimates and that it would be a great quarter compared to last year’s results. The latest daily oil price increases may have pushed these stocks higher even as they were disappointing analysts’ estimates.
The final point on this figure is that this lack of a decline after misses is a change from the recent trend in the past few quarters where stocks have experienced more volatility during earnings season. This change was blamed on the increase in ETFs where passive investors wouldn’t price in the changes in the business mid-quarter and then traders would go crazy after reports. The reality is earnings still matter; I wouldn’t say based on a half a quarter’s results that this is a trend change.
Looking at the S&P Dow Jones report on earnings, the number that sticks out to me is the margin estimates which have fallen substantially just like what happened during last quarter. Once again, I consider this bullish because there’s a limit to the amount margins can increase. If margin estimates for the quarter fall and earnings still come in great, it means sales are doing well. There’s no limit to sales growth like there is for margins. Last week margins were expected to be 10.40% in Q2. With the latest results, the margins are expected to be 10.18%. That’s only 8 one hundredths of a percentage point higher than the record in Q3 2014. I wouldn’t be surprised if the results fell below 10.10% which would be great because it gives more room for improvement in the next few quarters. Sales growth will still need to do the heavy lifting for Q3 and Q4 to do well. This quarter was great for sales growth as you can see from the chart below. According to FactSet, 73% of S&P 500 firms reported better than expected sales growth. This is the highest since at least Q3 2008 as the previous record was 72% set in Q2 2011.
According to S&P Dow Jones, the sales beats have been 70.88% which is also great. The best sector for sales growth beats was healthcare and the worst was energy. 85.71% of healthcare firms beat sales estimates and only 43.75% of energy firms beat sales expectations. It’s ironic to see healthcare doing so well as it has been the sector discussed the most in the media with the GOP trying to reform Obamacare or replace it. It’s impossible to determine what the legislation will do to healthcare earnings because hundreds of ideas are being discussed. I doubt that healthcare stocks have the changes priced into their share prices because of this uncertainty. When investing, the way to predict share prices is to make a prediction on something which isn’t known. I’m not saying to necessarily make a bet on healthcare based on potential legislation, but if you did know where it was headed, you could make money.
According to S&P Dow Jones the 70.88% sales beat rate was the third highest rate since Q2 2013. The great results pushed future expectations up across the board. There was a modest improvement in Q3 earnings estimates after they took a huge dive last week. The chart below shows the estimates for 2017 earnings and 2018 earnings went higher. The great results pushed up 2017 and the guidance pushed up 2018.
Conclusion
Earnings season has proven to justify the great stock performance this year as sales results have come in strong. Some of the companies beating estimates aren’t moving higher, but that’s not a cause for concern. This week will be another big week as it will determine if the final results are as good as the blended results look. The biggest report this week is on Tuesday when Apple reports after the bell. Everyone is looking forward to the 10-year anniversary of the iPhone which will be released in October. If Tim Cook gives any insight into what is coming from the new products, it will be more important to the stock than the quarter’s results.
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