As of today, the S&P 500 is expected to report earnings growth of 19.2% for the third quarter. What is the likelihood the index will report an actual earnings increase of 19.2% for the quarter?
Based on the average change in earnings growth due to companies reporting positive earnings surprises, it is likely the index will report earnings growth above 20% for Q3, but below the 25% growth reported in the previous two quarters (Q2 2018 and Q1 2018).
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 five years on average, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 4.6%. During this same period, 71% of companies in the S&P 500 have reported actual EPS above the mean EPS estimate on average. As a result, from the end of the quarter through the end of the earnings season, the earnings growth rate has typically increased by 3.5 percentage points on average (over the past five years) due to the number and magnitude of upside earnings surprises.
If this average increase is applied to the estimated earnings growth rate at the end of Q3 (September 30) of 19.2%, the actual earnings growth rate for the quarter would be 22.7% (19.2% + 3.5% = 22.7%).
If the index does report growth of 22.7% for Q3 2018, it will mark the third highest earnings growth for the index since Q3 2010 (trailing only the previous two quarters) and the third straight quarter of earnings growth above 20%.