Yearning for Earnings

Originally posted at Briefing.com

There is going to be a lot of attention paid to Greece and the eurozone in the coming week, yet it's important not to lose sight of what's happening in the stock market here. What's happening is that the S&P 500 is grinding its way higher while earnings per share (EPS) growth estimates are shifting their way lower.

Something will have to give. The assumption today is that it will be the earnings revision trend that reverses and not the market trend.

What Decline?

The assumption made by the market is not baseless. It has roots in the understanding that the final EPS growth rate is almost always higher than the projected growth rate. The first quarter reporting period provided the most recent reminder of that.

When the first quarter reporting period began, the consensus estimate called for a 3.2% decline in EPS growth. With the first quarter reporting period all but complete now, S&P Capital IQ reports that EPS increased 3.1%.

[Listen to: Jean-Marie Eveillard: Finding Value Today Like a Needle in a Haystack]

The blowout earnings report from Apple (AAPL) helped turn things around in a big way, yet the table below shows that Apple wasn't the only positive surprise in town. Even the energy sector played a part in the upward trajectory of first quarter EPS growth by virtue of the fact that its EPS decline was not as large as expected at the start of the reporting period.


Source: S&P Capital IQ

What S&P 500 companies produced in the way of positive surprises for EPS growth in the first quarter was lacking sorely in the way of top-line surprises.

According to S&P Capital IQ, 67% of the 492 companies that have reported so far beat EPS estimates whereas only 43% topped revenue estimates.

[Read: Dollar Strength May Revitalize “Constant Currency” Reporting]

In aggregate, first quarter revenues declined 1.7%. The downturn was driven by a 35.2% decline for the energy sector, yet robust growth was lacking for all sectors except health care (15.1%) and information technology (10.9%).

Not that weak revenue growth — or no revenue growth — has ever bothered the market that much since the Federal Reserve started down the QE road. Remember, that path in the market's mind has always been paved with good intentions of invigorating end demand that should produce solid revenue growth six months from now (and, if not then, six months after that).

The current consensus growth estimates, however, aren't supporting that assertion and that has a good bit to do with the lower energy prices and a stronger dollar compared to prior-year periods.


Source: S&P Capital IQ

Some Objective Hope

S&P 500 EPS growth estimates for the second quarter, third quarter, and fourth quarter have all come down since April 14 when JPMorgan Chase (JPM) got things rolling with its first quarter report. The better than expected results for the first quarter, however, have helped push up the calendar 2015 estimate to 0.6% from -0.3%.


Source: S&P Capital IQ

Despite the negative revisions, the S&P 500 has held up just fine, drawing support from the better than expected first quarter results and its understanding that analysts tend to lower the bar too far with their EPS growth estimates.

Added thoughts behind the market's hopeful EPS growth outlook have included:

  • Higher levels of employment that should lead to an increase in aggregate earnings and consumer spending
  • The assumption that GDP growth is certain to accelerate over the remainder of the year
  • Lower average gas prices than last year should bolster discretionary spending
  • The rebound in oil prices will stem the pace of downward earnings revisions for the energy sector
  • Signs of economic improvement in the eurozone and Japan
  • China's pursuit of major infrastructure improvement/expansion; and
  • An expectation business investment will accelerate as aggregate demand increases

What It All Means

The stock market may not be going anywhere fast this year, yet its 2.7% year-to-date gain does mesh with the thinking that the final EPS growth rate is apt to be at least two percentage points above the current growth estimate.

It could end up being more or, surprisingly, it could end up being less. The way things turn with EPS growth revisions will have a bearing on our market view.

The drop in EPS growth estimates from the end of 2014 is why on March 20 we lowered the bar for our price return expectations this year. Based on what we have seen since then, we are still not inclined to raise it.

Low single-digit EPS growth should beget low single-digit price returns all else equal.

Right now, though, the market is hoping things don't remain equal, but add up to more. That's the connection we can make anyway in the disconnect between price returns so far and the lowly EPS growth estimate for calendar 2015.

About the Author

Chief Market Analyst