To date, more than 90% of the companies in the S&P 500 have reported earnings for the third quarter. Of these companies, 74% have reported actual EPS above the mean EPS estimate, which is above the 5-year average of 69%. In aggregate, earnings have exceeded expectations by 4.6%, which is also above the 5-year average of 4.2%. Due to these upside surprises, the earnings growth rate for the S&P 500 has nearly doubled to 6.1% today from 3.1% on September 30.
Given the stronger performance of companies relative to analyst EPS estimates and the improvement in the growth rate over the past few weeks, how has the market responded to upside EPS and downside EPS surprises during the Q3 earnings season?
Similar to last quarter, the market has rewarded positive earnings surprises less than average and punished negative earnings surprises more than average during this earnings season.
Companies in the S&P 500 that have reported positive earnings surprises for Q3 have seen an increase in price of 0.4% on average from two days before the company reported actual results through two days after the company reported actual results. Over the past five years, companies in the S&P 500 that have reported positive earnings surprises have witnessed a 1.2% increase in price on average during this four-day window.
Overall, 47% of the S&P 500 companies that have reported positive earnings surprises have recorded a decline in price over this four-day window. The average price decline for these companies over this period was -3.6%. Of these companies, Under Armour (UAA) witnessed the largest price decline to date over the four-day window after reporting a positive earnings surprise. Before the opening bell on October 31, the company reported actual (adjusted) EPS of $0.22, compared to the mean EPS estimate of $0.19. From October 27 through November 2, the price of the stock fell by 27% (to $11.78 from $16.04).
Companies in the S&P 500 that have reported negative earnings surprises for Q3 have seen a decrease in price of -3.5% on average from two days before the company reported actual results through two days after the company reported actual results. Over the past five years, companies in the S&P 500 that have reported negative earnings surprises saw a decrease in price of -2.4% on average during this four-day window.
Overall, 67% of S&P 500 companies that reported negative earnings surprises for Q3 recorded a decline in price over this four-day window. The average price decline for these companies over this period was -6.4%. Of these companies, Envision Healthcare (EVHC) had the largest price decline to date over the same four-day window after reporting a negative earnings surprise. After the closing bell on October 31, Envision Healthcare reported actual (adjusted) EPS of $0.73, compared to the mean EPS estimate of $0.88. From October 27 through November 2, the price of the stock fell by 37% (to $27.25 from $43.40).
Why is the market rewarding positive EPS surprises less than average and punishing negative EPS surprises more than average?
In aggregate, it is not likely due to forward EPS guidance or analyst revisions to EPS estimates for the fourth quarter. To date, fewer S&P 500 companies have issued negative EPS guidance for Q4 2017 (58) compared to the five-year average (80). In aggregate, analysts made smaller cuts to fourth quarter EPS estimates during the month of October compared to recent averages.
However, it may be due to the high valuation of the index relative to recent averages. As of today, the forward 12-month P/E ratio for the S&P 500 is 18.0. This forward 12-month P/E ratio is above the four most recent historical averages for the S&P 500: five-year (15.7), 10-year (14.1), 15-year (14.5), and 20-year (16.0). Prior to the month of October, the forward 12-month P/E had not been equal to (or above) 18.0 since 2002. Thus, despite the number and magnitude of positive earnings surprises in recent quarters, the market may be reluctant to push valuations even higher in aggregate.