Q1 earnings season begins next week. What to expect, and why it’s now a “stock picker’s” market
Editor’s note: tomorrow we will be closed along with the markets in observance of Good Friday. Have a safe, and wonderful Easter.
So, just how bad is it?
We’re about to get an idea …
First quarter earnings season kicks off in under a week, starting with the financial sector. JPMorgan and Wells Fargo are set to report on April 14, marking the beginning of what is certain to be a brutal reporting period.
It will also be a unique earnings season. That’s because “beating” or “missing” an estimate will need to be taken with a massive grain of salt. Only a handful of business-models have been able to sail through the COVID-19 crisis unscathed (think telemedicine). The majority have been impacted by lockdowns and social distancing — some mildly, some severely.
So, the question this earnings season won’t necessarily be how a company performs relative to analyst expectations. Instead, there will be a new set of questions …
What’s the scope of the damage?
Is management offering any guidance on earnings and operations looking forward? Some companies that have already pulled their guidance for 2020 include Quest Diagnostics, Gap, Square, Best Buy, Kohl’s, Yelp, FedEx, Ulta, Expedia, Southwest, United Airlines, Visa, Twitter, Target, Domino’s Pizza, and Deere.
How might a staggered, delayed re-opening of the economy impact future earnings? For example, a restaurant chain could suffer a drawn-out period of depressed earnings as diners are nervous about venturing out.
And when considering all this individual-company information collectively, what does it reveal about the timing of a broad recovery?
***On that note, it’s looking increasingly like investors need to be patient in their expectations
Famed investor Louis Navellier made this point to his subscribers in his Tuesday Growth Investor update:
It has become clear, folks, that we’re not going to have a “V-shaped” recovery, though that’s always the hope after a sharp market decline. We’re going to have a “U-shaped” recovery.
In a surging bull market, even average stocks can climb. It’s the old dynamic of “a rising tide lifts all ships.” High-velocity, V-shaped recoveries tend to lift even average companies. And even though it may not feel like it, we’ve actually seen this in recent weeks.
As you can see below, the S&P — which contains over 500 companies, many over them “average” — is up 25% since our late-March low.
If we look at the year-to-date chart, this “V” recovery is easier to see …
But in Louis’ update, he notes why these broad gains aren’t likely to continue:
The bears have also been forced, through “margin calls” at the brokers, into a lot of “short-covering,” or automatic buying.
So, in the upcoming days I expect that short-covering to cease. A lot of my high-quality stocks have broken out, which is very encouraging. But we want to see that continue, and we want to see the low-quality stuff basically lose its momentum a bit. All I care to see is the creme de la creme rise.
Given this, we can’t bank on more “free passes” for average companies. Looking forward, if a stock is going to perform well, it will be based purely on its own merits and strength.
Back to Louis for what this means about the overall market:
… I envision more of a stock-picking market moving forward, and less of just a pure sector market.
I’m a stock-picker — so I’m comfortable with that. The bottom line is, you should be prepared for an increasingly narrow market, with drastic differences between winners and losers.
We’ll know who those winners and losers are as the first-quarter earnings announcement season gets underway.
***So, what exactly do we know about the upcoming first-quarter earnings season?
For this answer, let’s turn to FactSet. It’s “the” resource used by investment professionals for earnings data.
Even though, as noted above, we should take earnings estimates with a grain of salt, they can still be instructive as a crude benchmark going forward. Here’s FactSet’s summation of what it expects from Q1:
Earnings Growth: For Q1 2020, the estimated earnings decline for the S&P 500 is -7.3%. If -7.3% is the actual decline for the quarter, it will mark the largest year-over-year decline in earnings reported by the index since Q3 2009 (-15.7%).
Earnings Revisions: On December 31, the estimated earnings growth rate for Q1 2020 was 4.3%. All eleven sectors have lower growth rates today (compared to December 31) due to downward revisions to EPS estimates.
Earnings Guidance: For Q1 2020, 72 S&P 500 companies have issued negative EPS guidance and 32 S&P 500 companies have issued positive EPS guidance.
Valuation: The forward 12-month P/E ratio for the S&P 500 is 15.3. This P/E ratio is below the 5-year average (16.7) but above the 10-year average (15.0).
Earnings Scorecard: For Q1 2020 (with 20 companies in the S&P 500 reporting actual results), 15 S&P 500 companies have reported a positive EPS surprise and 14 S&P 500 companies have reported a positive revenue surprise.
Keep in mind, the differential between analysts’ forecasts for price targets and earnings hasn’t been this wide in 20 years.
Given the uncertainty around Q1 earnings, as well as this being a “stock picker’s” market, what’s the best way to identify strong stocks amidst the many average stocks?
Try Louis’ Portfolio Grader.
For any newer Digest readers, Louis’ Portfolio Grader is a free tool that grades stocks on eight key fundamental factors: sales growth, operating margin growth, earnings growth, earnings momentum, earnings surprises, analyst earnings revisions, cash flow, and return on equity. It’s a great way to get an instant read on the fundamental strength of a stock you might be considering adding to your portfolio.
In Louis’ update, he showed how this works in real-time.
Here’s a snapshot of the companies Louis ran through his Grader …
And here is his bottom-line takeaway:
The companies that offered up good news were the ones with strong Quantitative Grades — my proprietary measure of buying pressure on Wall Street … which happens to be the single most important factor in a stock’s long-term success. The companies that didn’t … fell short.
If you’re trying to gauge how well your own stocks are making it through today’s market, the Portfolio Grader is a fantastic, convenient tool offering you a quick snapshot. You can also use it as a screener for any stocks you might be considering adding to your portfolio.
***Looking forward, Louis continues to stick by his system, which focuses on a company’s earnings power above all else
After all, cold, impartial numbers don’t lie, which is why they’re at the heart of Louis’ market approach.
I’m going to count on earnings to propel my stocks higher — and I’m going to trim some stocks that have gotten too volatile, or sell them outright …
In the meantime, don’t be surprised if we continue to oscillate more, which would be perfectly normal in the current market environment. Regardless, I’m encouraged by the action this week, and I hope you are, too. We’ll get through this together.
Wrapping up, earnings season is about to get underway so hold onto your hats. A few weeks from now we’ll have a much better idea of where the market stands, as well as what we might expect going forward.
We’ll keep you updated here in the Digest.
Have a good evening,
Jeff Remsburg
