Companies have done a poor job of surpassing analysts’ expectations this earnings season, and that’s an especially big problem given how low expectations have fallen.
According to Bespoke Investment Group, 58.8 per cent of the 2,192 U.S. companies that have reported their results so far have topped consensus earnings expectations. While that might sound okay, it’s not: It marks the third straight quarterly decline and it is considerably below the 14-year average “beat rate” of 62.3 per cent.
“If earnings season were to end today, it would be the lowest reading we’ve seen since the bull market began as well,” Bespoke said on its blog.
Beat rates are very important to investors because the market tends to care more about how earnings have fared next to expectations, rather than whether the actual earnings have moved up or down from the previous year. The problem with the current earnings season, though, is that consensus expectations from analysts have been going down, down, down – deflating the importance of beating lowered expectations.
Well before the start of the second-quarter earnings season, analysts had been forecasting earnings of about $28 (U.S.) per share for all the companies within the S&P 500. By the time companies began reporting their results, that forecast had slid to about $25.50 – a 9 per cent deterioration.
Expectations for third-quarter earnings have fallen even more, from earlier expectations of about $29 a share to the current forecast of $25 a share.
“Analysts have continued to aggressively cut EPS estimates for [the second half of 2012] and next year, as evidenced by the drop in the three-month estimate revision ratio in July,” said Savita Subramanian, equity & quant strategist at Bank of America, in a note to clients released last week.
Even so, she believes the consensus expectation for earnings is unachievable: “We think the downward revision cycle has further room to run, and management guidance has similarly gotten more cautious with twice as many companies now guiding down as up.”
Still, the bad news on earnings doesn’t necessarily mean that the stock market is going to struggle. Ronald Dottin, U.S. quantitative analyst at RBC Dominion Securities, pointed out in a recent note that consensus earnings expectations show that earnings growth will slow to 5.8 per cent by the end of the year, which is slightly below the long-term average of 6 per cent growth.
“However, when we look back at the average annual returns for equities in years where earnings were below trend, we found the S&P 500 still yields a 6 per cent return,” he said. “That’s obviously lower than the average long-term return for stocks, but in the context of recent years, it would most likely be viewed as a solid return in the eyes of most equity investors.”