As of today, the S&P 500 is expected to report (year over-year) earnings growth of 2.4% for the third quarter, which would be the lowest earnings growth reported by the index since Q3 2020. Given that most S&P 500 companies report actual earnings above estimates, what is the likelihood the index will report actual growth in earnings of 2.4% for the quarter?
Based on the average improvement in earnings growth during the past few earnings seasons due to companies reporting positive surprises, it is likely the index will report earnings growth between 6% and 7% 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 rate for the company for the quarter is now 10%, five percentage points above the estimated growth rate (10% - 5% = 5%).
In fact, the actual earnings growth rate has exceeded the estimated earnings growth rate at the end of the quarter in 39 of the past 40 quarters for the S&P 500. The only exception was Q1 2020.
Over the past ten years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 6.5% on average. During this same period, 73% 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 increased by 5.5 percentage points on average (over the past ten years) due to the number and magnitude of positive earnings surprises. If this average increase is applied to the estimated earnings growth rate at the end of Q3 (September 30) of 2.8%, the actual earnings growth rate for the quarter would be 8.3% (2.8% + 5.5% = 8.3%).
Over the past five years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 8.7% on average. During this same period, 77% 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 increased by 8.0 percentage points on average (over the past five years) due to the number and magnitude of positive earnings surprises. If this average increase is applied to the estimated earnings growth rate at the end of Q3 (September 30) of 2.8%, the actual earnings growth rate for the quarter would be 10.8% (2.8% + 8.0% = 10.8%).
However, it should be noted that both the 5-year average improvement and the 10-year average improvement in the earnings growth rates during an earning season have skewed higher recently due to the unusually strong performance of actual earnings relative to earnings estimates for S&P 500 companies coming out of the lockdowns caused by the COVID-19 pandemic. From Q2 2020 through Q4 2021, actual earnings reported by S&P 500 companies exceeded estimated earnings by 16.2% on average. During this same period, 83% of companies in the S&P 500 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 increased by 17.3 percentage points on average (during these seven quarters) due to the number and magnitude of positive earnings surprises.
More recently, the improvement in the earnings growth rate has been below the 5-year average and below the 10-year average. Over the past two quarters (Q1 2022 and Q2 2022), actual earnings reported by S&P 500 companies exceeded estimated earnings by only 4.0% on average. During this same period, 76% of companies in the S&P 500 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 only increased by 3.5 percentage points on average (during the past two quarters) due to the number and magnitude of positive earnings surprises.
If this average increase is applied to the estimated earnings growth rate at the end of Q3 (September 30) of 2.8%, the actual earnings growth rate for the quarter would be 6.3% (2.8% + 3.5% = 6.3%). If the S&P 500 reports year-over-year growth in earnings of 6.3% for Q3, it would mark the third straight quarter that the index reported earnings growth below 10%.
Will the performance of actual earnings relative to earnings estimates trend closer to the last few quarters or closer to the 5-year and 10-year averages in Q3 2022?
Of the 20 S&P 500 companies that have reported actual earnings for Q3 2022 to date, 70% have reported actual EPS above the mean EPS estimate. In aggregate, however, actual earnings reported by these 20 companies have come in below estimated earnings by 4.5%.
Therefore, at this very early stage of the Q3 earnings season, the number of positive earnings surprises and the magnitude of positive earnings surprises are below the 10-year average, the 5-year average, and the trailing two-quarter average. Since June 30, the earnings growth rate for the S&P 500 has declined by 0.4 percentage points (to 2.4% from 2.8%). Thus, it would seem likely that the improvement in the earnings growth rate during the Q3 earnings season will trend closer to the lower numbers of the past two quarters than the higher numbers of the 5-year average and the 10-year average.
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