While all the attention has been on market volatility in China and the machinations of bailout negotiations in Greece, we’ve quietly crept up on the start of 2015’s second-quarter earnings season.
Alcoa (AA) kicked things off last week; but we’re headed into the meat of the reporting season this week with JPMorgan (JPM), Wells Fargo (WFC), and Johnson & Johnson (JNJ) reporting on Tuesday. Other big reporters later in the week include Netflix (NFLX), Intel (INTC), Bank of America (BAC), Google (GOOG, GOOGL), General Electric (GE) and Goldman Sachs (GS).
Clearly, the calendar is jam-packed.
Here are four things investors absolutely need to know … starting with the fact analysts are penciling in the worst outright decline in earnings since 2009.
The two big dynamics that corporate managers blamed for ho-hum results in the first quarter — the strong dollar (weighing on foreign profits) and weak crude oil prices (hitting energy revenues) — are back in play. In fact, according to FactSet data, we’re on track for the first year-over-year earnings drop for S&P 500 earnings — with a -4.4% decline expected — since the middle of 2012.
It would also represent the largest YoY earnings decline, on an absolute basis, since the third quarter of 2009.
This is being overwhelmingly caused by the drag from the energy sector as shown in the chart above.
Traditionally, management teams have tried to tamp down expectations so they can report upside surprises and juice their stock price (and thus, the value of their own stock options) when the actual numbers are released. Over the past four years, 72% of S&P 500 companies have reported actual earnings per share above the mean estimate (on average).
As a result, the overall earnings growth rate has over the last four years increased 2.9% on average from the end of the quarter to the end of the resulting earnings reporting season.
Something similar was expected to happen heading into the first-quarter reporting season, with estimates braced for a -4.6% decline in earnings per share. The actual result was 0.8% growth thanks to shrewd earnings management and accounting trickery as shown above. History suggests a repeat performance is likely.
Factors to Watch For
Much depends on how well corporate treasurers have managed the strong U.S. dollar. An analysis of the 24 S&P 500 companies that have already reported results reveals that 17 have cited the strong dollar or currency movements as having a negative impact on results vs. just one — Walgreens Boots Alliance (WBA) — mentioning the situation in Greece, but in the context of its impact on the overall currency market.
Looking ahead, analysts don’t currently expect earnings growth to return until the fourth quarter, while revenue growth isn’t expected to return until the first quarter of 2016. Given this, stocks look fully valued with the S&P 500’s forward price-to-earnings multiple at 16.2 — above its five-year average of 13.9 and above the 10-year average of 14.1.
At the sector level, focus will be on the energy sector. It’s been hit the hardest (earnings expected to fall -57.4%), especially the shale players in the gas exploration and production space. Without the drag from energy, overall S&P 500 earnings growth would be expected to total 2% YOY.
Yet it’s also an area where prices and valuations are elevated on the implicit assumption that energy prices will soon rise again: The price-to-earnings multiple for the energy sector stands at 23.8 vs. a 10-year average of 12.6.
We’ll see if the optimists are proved right.
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