Green Grass and High Tides: Earnings Stellar But Not Without Risk

by Liz Ann Sonders of Charles Schwab, 11/21/17

Key Points

  • The book is closing on third quarter earnings and it was another stellar season.

  • Both earnings and revenues were strong; and importantly, the “beat rates” were well above average.

  • The outlook for 2018 is bright, but we are on watch for an expectations bar that gets set too high.

With third quarter earnings season nearly complete, I wanted to give a shout-out to another strong showing by U.S. companies. The topic lends itself to a table-heavy, prose-light report this week.

The inflection point in earnings growth from a four-quarter earnings contraction ending after last year’s second quarter; to the subsequent surge has arguably been the most important catalyst for the market’s strength over the past year (more so than the election). The most notable driver of the massive turn in profitability has been the energy sector—which drove both the contraction and the recovery. But it’s not just a story of energy’s spark.

The table below shows not only S&P 500 results/forecasts overall, but sector-based earnings growth as well. It covers the period since earnings moved from contraction to expansion through estimates a year from now. It’s clear that energy has been a major factor in the improved growth over the past year; but there are other sectors—most notably technology—reporting strong growth.

Earnings growth rates

Source: Thomson Reuters, as of November 20, 2017. *17Q1 Energy sector: prior year earnings are negative.

I often note that when it comes to the stock market and underlying fundamentals—either of the earnings or economic variety—“better or worse matters more than good or bad.” In other words, rate of change matters more than level, and relative matters more than absolute. As such, the so-called “beat rate” (the percentage of companies reporting results above analysts’ consensus estimates) is tracked and watched closely by investors.

As you can see in the table below, the beat rate for third quarter earnings is 72% to-date—well above the historic average (since 1999) of 62%. The beat winners have been technology and financials (we have outperform ratings on both); while bringing up the rear are utilities and telecom (we have underperform ratings on both).