Companies are in a position to report higher earnings than expected for the third quarter. That doesn’t mean their stocks are going to soar.
The critical point is that third-quarter results aren’t going to be spectacular. Analysts expect aggregate sales for companies in the
S&P 500
to be about 1.7% higher than they were last year, according to FactSet, even though it was in the third quarter of 2022 that companies began to disclose slowing growth in sales.
The fact that sales will only grow in the low single digits this quarter relative to of a fairly low base last year is yet another indication that the economy isn’t exactly firing on all cylinders.
That won’t help third quarter earnings-per-share results, which are expected to drop about 0.3%. Profits are growing slower than revenues because margins are narrowing as the cost of labor rises faster than sales.
The good news in all of this is that analysts’ expectations aren’t demanding. Wall Street has been cautious: Aggregate estimates for per-share earnings at S&P 500 companies have fallen about 0.1% in the past month.
“Because the bar is set so low this reporting season, the market is primed for some upside surprises,” wrote Kyle Rodda, senior market analyst at Capital.com.
The few earnings reports that have trickled in so far have been better than expected. Eighteen out of 21 companies have beaten EPS estimates, according to Wells Fargo.
PepsiCo
(PEP), for example, surprised the market. Price increases were enough to boost total sales by just under 7%, even with the volume of products sold declined a bit. Profit margins increased more than expected, enabling EPS to beat expectations and rise 14%.
The problem for the broader stock market is that prices already reflect optimism about earnings, so reporting season isn’t likely to bring about large gains for the S&P 500. The index is up by double digits this year and trades at about 18 times the EPS expected for the coming 12 months, up from just under 17 times to start the year.
That is expensive, given the fact that bond yields have gained this year, making fixed income more attractive. Earnings would have to beat expectations by a particularly wide margin to move stock prices substantially higher.
That dynamic is why the few companies that have reported their earnings so far have encountered a “mostly ‘sell-the-news’” reaction to results, wrote Chris Harvey, chief U.S. equity strategist at Wells Fargo. Shares of the 18 firms that beat estimates have underperformed the S&P 500 by an average of almost a percentage point the trading day after earnings, according to the bank.
The reality is that the only companies with any shot at achieving stock-price gains after earnings are those that offer solid guidance. Past earnings tell investors what has already happened, but investors are concerned that the economy is likely to continue to weaken in the face of higher rates.
The market needs to be highly confident—not just a little confident—about a company’s profit outlook in order for a stock to gain. That is especially true given that so many are expensive.
“The more interesting details will be in company guidance for 2024 and whether they can live up to the lofty expectations of the markets,” wrote Rodda.
Companies scheduled to release their results this week include
Delta Air Lines
(DAL), Domino’s Pizza (DPZ),
Fastenal
(FAST),
JPMorgan Chase
(JPM),
Citigroup
(C), and others.
Don’t expect this earnings season to send the stock market to new highs.
Write to Jacob Sonenshine at [email protected]
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