Thank You, Consumer, and Other Sentiments From Q1 Earnings

First-quarter earnings largely surprised to the upside, but expectations also had been guided down. What does the latest earnings news mean for stock investors? Carrie King, Global Deputy CIO of BlackRock Fundamental Equities, offers three observations.

Sentiment #1: Surprise. But a low bar is easier to clear

Exceeding expectations isn’t as hard when they’re set (or reset) low. That was a big part of what we saw in the first-quarter earnings season. While nearly 80% of S&P 500 companies beat analyst estimates on earnings, it was in the context of expectations that had been downgraded from the start of the quarter. Importantly, the earnings beats were met with muted share price appreciation, perhaps an investor acknowledgment of the low bar. Meanwhile, companies that missed their earnings estimates suffered greater price punishment than is typical.

Overall, the level of the S&P 500 was little changed over the reporting season, despite the relatively larger frequency of positive earnings surprises. And year-to-date, it’s been the top-five stocks in the index that have carried the day. Index performance would otherwise be negative for the year. Our read on this: The market is rewarding quality, and this presents an opportunity for active stock pickers.

While the market is assigning additional value based on generative artificial intelligence (AI) prospects, these ultra-cap companies possess all-important quality characteristics like strong cash flows, fortress balance sheets, and diversified revenue streams. We expect companies with similar attributes to outperform as investors key in on potential margin compression in the coming quarters.

Sentiment #2: Gratitude. Thank you, consumer

In large part, companies have consumers to thank for their good Q1 fortune. All sectors exceeded their sales growth expectations. While the top line (sales) looked good, the bottom line (profits after subtracting costs) showed that margins may be coming under pressure. Certainly, they are retreating from their post-pandemic highs, as shown in the chart below.

Profit margins retreating from historic highs