As of today, the S&P 500 is expected to report a year-over-year decline in earnings of -3.9% for the fourth quarter, which would mark the first year-over-year decline in earnings reported by the index since Q3 2020 (-5.7%). Given that most S&P 500 companies report actual earnings above estimates, what is the likelihood the index will report an actual decline in earnings of -3.9% for the quarter?
Based on the average improvement in the earnings growth rate during earnings seasons over the past five to 10 years, the index would report earnings growth for Q4. However, based on the below-average improvement in the earnings growth rate over the past two earnings seasons, the index would still report a year-over-year earnings decline for Q4.
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 38 of the past 40 quarters for the S&P 500. The only exceptions were Q1 2020 and last quarter (Q3 2022).
Over the past 10 years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 6.4% 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 5.4 percentage points on average (over the past 10 years) due to the number and magnitude of positive earnings surprises. If this average increase is applied to the estimated earnings decline at the end of Q4 (December 31) of -3.2%, the actual earnings growth rate for the quarter would be 2.2% (-3.2% + 5.4% = 2.2%).
Over the past five years, actual earnings reported by S&P 500 companies have exceeded estimated earnings by 8.6% 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 7.8 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 decline at the end of Q4 (December 31) of -3.2%, the actual earnings growth rate for the quarter would be 4.6% (-3.2% + 7.8% = 4.6%).
Over the past two quarters (Q2 2022 and Q3 2022), however, actual earnings reported by S&P 500 companies have exceeded estimated earnings by only 2.5% on average. During these two quarters, 72% 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 0.9 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 decline at the end of Q4 (December 31) of -3.2%, the index would report an actual decline in earnings of -2.3% (-3.2% + 0.9% = -2.3%).
How are the numbers trending to date? Of the 29 S&P 500 companies that have reported actual earnings for Q4 2022 through January 13, 79% have reported actual EPS above the mean EPS estimate. In aggregate, actual earnings reported by these 29 companies have exceeded estimated earnings by 7.7%. Thus, at this very early stage of the earnings season for Q4, the number of companies reporting positive EPS surprises and the magnitude of these EPS surprises are trending closer to their 5-year averages. Since December 31, the earnings decline for the S&P 500 has increased by 0.7 percentage points (to -3.9% from -3.2%).
This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.