October 27, 2022
ICYMI: earnings matter, like a lot. Every year, markets are treated to four “earnings seasons.” On an individual level, these quarterly reports can provide investors with insight into the companies they own. These insights (mostly EPS, revenue, and business updates) have a tendency to move stocks quite dramatically.
At a more macro level, the performance of individual companies can be generalized to show us how entire sectors and industries are performing. We can become even more broad by taking a look at how entire indexes, countries, and global markets are performing.
That said, we’ve just exited one of these pivotal seasons. Q2 earnings are now (mostly) over. Needless to say, they left investors with confidence that the COVID pandemic has done its worst. Let’s take a look at how the S&P 500, one of America’s largest indexes, made out in the latest quarter.
How Do We Evaluate Earnings?
To evaluate how Q2 treated some of America’s largest companies, we’ll be taking a look at Refinitiv Lipper’s S&P 500 Earnings Dashboard. As of Sept. 24, 2021 (the day we collected data for this article), 499 of the 500 companies in the S&P 500 had reported. This is a pretty comfortable number of companies, so we proceeded in the absence of the one straggler.
Refinitiv’s dashboard does a lot of heavy-lifting, making it one of the best sources to get earnings updates. They go through the trouble of sifting through individual sectors, calculating growth rates, and seeing how companies did compared to what analysts expected. The latter point is perhaps the most crucial: analyst estimates are one of the best indicators of how a company is supposed to do. That’s because analysts toil away, attempting to predict the future (oftentimes, relatively conservatively). In essence, the aggregate intelligence of analysts has become a de facto standard to measure earnings performance. When a company beats these estimates, it’s considered a beat. When they don’t, it’s considered a bust.
There are two more things that you should know. When analysts are reviewing companies, they often look at two figures in particular: revenue and earnings. Revenue refers to the total amount of money that a company generated in a period of time, while earnings generally refers to an amount of money earned per share. In other words, revenue is often a big number (i.e. $283 million, $1.3 billion), while earnings are smaller (i.e. $1.83/share, ($0.54)/share).
Now that you’ve got the basics, here are a few takeaways from Refinitiv’s report:
Analysts Expected Worse
Most financial reports look at year-over-year (YoY) performance. Since 2020 was a particularly abysmal year because of the COVID pandemic, that has helped 2021 look really good.
According to Refinitiv, 87.8% of S&P 500 companies reported earnings above analyst expectations. Another 3% met analyst expectations. In other words, only about ~9% of S&P companies did worse than what analysts expected. Those figures are relatively unprecedented. In fact, it set a record for the greatest percent of analyst beats. The last time this figure was this high was 1994.
Refinitiv says that the “long-term average” for revenue beats is 66%. That’s to say that roughly 2 in 3 companies beat analyst expectations, while the other 1 in 3 either match or underperform the estimates.
The high volume of beats, compared to historical averages, implies that analysts expected companies to do worse. Another way of saying that is: companies did better than analysts expected.
It Doesn’t Get Much Better Than This
As we already said, COVID turned 2020 into an abysmal earnings season. That’s one reason why this quarter looks rock solid.
Blended earnings growth for the S&P 500 was up 96.3% YoY. What that means is that earnings were nearly 2x as good as they were this time last year. As you’ve already probably deducted, being 2x better than 2020 is probably not such an impressive feat. However, those growth rates are just as unprecedented as the beats.
When you take a step back from earnings growth and look at revenue growth, the figures are still high, but not as hefty. Blended revenue growth was up 25.2% YoY.
Overall, these kinds of figures are pretty impressive. Even though 2020 was bad, these numbers suggest that there has been a strong recovery, now that some of the worst effects on the economy have been mitigated.
Some Sectors Did Better Than Others
Though the S&P 500 did exceptionally well, some sectors did worse than others. However, that might not mean a whole lot. After all, all sectors did great in Q2 2021.
Refinitiv reported that the utilities and materials sectors left the most to be desired in earnings. Out of the 28 tracked utilities companies, 71% were above analysts’ estimates. For materials, which also tracked 28 companies, the figure was 75% beats.
The best-performing earnings sectors were financials and technology, which both boasted 95% beats.
However, what analysts expected might not be the most meaningful figure to compare in this case. Let’s take a look at the growth rates of various sectors for more insight:
High-Growth Industrials, Consumer Discretionary, and Energy
Out of the 11 sectors, some sectors reported stronger earnings and revenue growth than others. In this case, it just so happens that industrials, consumer discretionary, and energy led the earnings growth in the quarter.
Industrials saw astronomical earnings growth, up 698% according to Refinitiv. In the quarter, the sector posted a 28.5% YoY increase in revenue, which beat the S&P’s 25.2% revenue growth YoY. Consumer Discretionary also saw impressive growth in the quarter, with earnings growth up 380% YoY. The sector’s revenue was up 35.2% YoY.
However, above all other industries, the most impressive sector might have been energy. The Energy sector, which mostly covers oil & gas players and energy service companies, saw a 243% blended earnings growth rate. The sector’s revenue saw the most pronounced growth, likely a side effect of a weak 2020 for oil & gas. 2021 has been more generous to the industry so far.
Index Valuations Look Acceptable
Despite fears that stocks are overvalued and the market is due for correction, major index valuations had mostly acceptable P/E ratios. The P/E ratio, or price-to-earnings ratio, is one measure of a stock’s value. As its name implies, it measures the company’s stock price against its per-share earnings.
As it would turn out, there’s a way to calculate an entire index’s P/E ratio. You can take the price of an index and weigh it against the share-weighted earnings of the entire index. As of Sept. 23, the S&P 500’s forward P/E was 21.5. That was a slight premium over the mean for the index (15.95), but a pretty acceptable figure considering the state of the economy.
So, what does forward P/E point to? Well, forward P/E looks at the S&P 500’s current price and compares it to future earnings expectations. Specifically, forward P/E is looking at the next four quarters of earnings for the S&P at-large. As of Sept. 24, that figure is expected to be $206.60/share for the next 12 months. By weighing that EPS against the last close, you get 21.5.
The same methodology can be used to generalize results from other indexes. According to Refinitiv, the S&P 400 and S&P 600 had forward P/Es in the 16s. The most overvalued of the indexes was the Russell 2000, with a forward P/E of 29.3.
Earnings Are Expected To Rise, Generally Speaking
You probably clicked this article because you want to know one thing: can we expect the earnings growth to continue? The answer is: probably.
Analysts expect Q3 2021 and Q4 2021 to be less exciting from an earnings perspective. However, they expect earnings to continue to rise through 2023. Earnings are a little bit more sensitive than revenue, though. For revenue, analysts expect figures to continue to climb in each coming consecutive quarter.
Analysts might be bracing for an earnings-related growth slowdown, however. Several of the figures in the expanded Refinitiv report show that estimated earnings growth for 2022 is expected to be lower. The reason why, as you’ve already likely guessed, is because the growth came early (we’re seeing it now). Overall, much of the growth we’re seeing is just the “return to normal.”