As of today, the S&P 500 is expected to report a decline in earnings of -6.8% for the fourth quarter. What is the likelihood the index will report an actual decline in earnings of -6.8% for the quarter?
Based on the five-year average improvement in earnings growth during each earnings season due to companies reporting positive earnings surprises, it is likely the index will still report a year-over-year decline in earnings for Q4. However, if S&P 500 companies repeat in the fourth quarter their unusually strong earnings performances relative to analyst expectations of the past two quarters, the S&P 500 will likely report earnings growth 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 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 6.3%. During this same period, 74% 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 4.0 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 decline at the end of Q4 (December 31) of -9.2%, the actual earnings decline for the quarter would be -5.2% (-9.2% + 4.0% = -5.2%). If the S&P 500 reports a year-over-year decline in earnings in Q4, it would mark the seventh time in the past eight quarters in which the index has reported a year-over-decline in earnings.
However, during the past two quarters (Q2 2020 & Q3 2020), actual earnings reported by S&P 500 companies have exceeded estimated earnings by 21.3% on average. During these two quarter, 84% 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 14.0 percentage points (on average) due to the number and magnitude of positive earnings surprises over these past two quarters.
If this average increase is applied to the estimated earnings decline at the end of Q4 (December 31) of -9.2%, the actual earnings growth rate for the quarter would be 4.8% (-9.2% + 14.0% = 4.8%). If the S&P 500 reports year-over-year growth in earnings of 4.8%, it would mark the first time the S&P 500 has reported year-over-year earnings growth since Q4 2019 (0.8%) and the highest year-over-year earnings growth reported by the index since Q4 2018 (13.2%).
Of the 26 S&P 500 companies that have reported actual earnings for Q4 2020 to date, 96% have reported actual EPS above the mean EPS estimate. In aggregate, actual earnings reported by these 26 companies have exceeded estimated earnings by 26.2%. Thus, at this very early stage of the Q4 earnings season, the performance of earnings relative to estimates is trending closer to the numbers of the previous two quarters rather than the five-year average. Since December 31, the earnings decline for the S&P 500 has improved by 2.4 percentage points (to -6.8% from -9.2%).
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