Predictions for actual earnings growth and earnings surprises heading into Q3 earnings season

As of today, the S&P 500 is projected to report year-over-year growth in earnings of 4.5% for the third quarter. What is the likelihood the index will report actual earnings growth of 4.5% for the quarter?

Based on the average number of companies reporting actual earnings above estimated earnings in recent years, it is likely the index will report actual earnings growth higher than 4.5% for Q3.

When companies in the S&P 500 report actual earnings above estimates during an earnings season, the overall earnings growth rate for the index increases because the higher actual EPS numbers replace the lower estimated EPS numbers in the calculation of the growth rate. For example, if a company is projected to report EPS of $1.05 compared to year-ago EPS of $1.00, the company is projected to report earnings growth of 5%. If the company reports actual EPS of $1.10 (a $0.05 upside earnings surprise compared to the estimate), the actual earnings growth for the company for the quarter is now 10%, five
percentage points above the estimate growth rate (10% - 5% = 5%).

Over the past four years, 72% of companies in the S&P 500 have reported actual EPS above the mean EPS estimates on average. As a result, the earnings growth rate has increased by 2.3 percentage points on average from the end of the quarter through the end of the earnings season due to these upside earnings surprises.

If this average increase is applied to the estimated earnings growth rate at the end of Q3 (September 30) of 4.6%, the actual earnings growth rate for the quarter would be 6.9% (4.6% + 2.3% = 6.9%).

It is interesting to note that for Q2 2014, the projected growth rate of 7.7% (based on the trailing 4-year average) was just 0.2 percentage points above the actual earnings growth rate of 7.5% for the quarter.