As of today, the S&P 500 is projected to report a year-over-year decline in earnings of 5.5% for the third quarter. What is the likelihood the index will report an actual earnings decrease of 5.5% 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 year-over-year decrease in earnings for Q3, but it will likely be smaller than 5.5%.
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 estimated 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 2.9 percentage points on average over the past four years from the end of the quarter through the end of the earnings season, due to the large number of upside earnings surprises.
If this average increase is applied to the estimated earnings decline at the end of Q3 (September 30) of -5.1%, the actual earnings decline for the quarter would be -2.2% (-5.1% + 2.9% = -2.2%). It is interesting to note that for Q2 2015, the actual decline for the quarter of -0.7% was smaller than the projected decline of -1.6% on July 10 (based on this expected average increase in the earnings growth).