Breaking down the earnings picture as estimates fade


Note: The following is an excerpt from this week’s article. Earnings Trends report. You can access the complete report which contains actual historical and detailed estimates for the current and next periods, please click here>>>

Here are the key points:

  • The picture emerging from the third quarter 2022 earnings season continues to run counter to pre-season fears of an impending earnings cliff. Overall corporate profitability isn’t great, but it’s not bad either. That said, estimates for future periods are steadily declining, with the trend of revisions accelerating in recent days.
  • Looking at Q3 2022 as a whole, total S&P 500 earnings are currently expected to rise +2.0% from the same period last year, with revenue up +10.7 %. Excluding contributions from the energy sector, third-quarter earnings for the rest of the index would be -5.6% below the level of the previous year.
  • Looking at the calendar year chart, total earnings for the S&P 500 are expected to be up +5.7% in 2022 and +3.8% in 2023. On a non-energy basis, total earnings of the 2022 index would be down -1.2% (instead of +5.7%, with Energy).
  • The widely held view that earnings estimates do not match the economic reality on the ground is misguided as it looks at the bigger picture at the index level where estimates for the energy sector have historically been positive.

The focus of late has been on disappointing results from the tech sector, particularly mega-cap operators Amazon AMZN, Alphabet GOOGL, Meta META, Microsoft MSFT and Apple AAPL; we called this group the “Big 5 Tech Players”.

Of this group, Apple fared much better, restoring its leadership credentials and its status as the “Rock of Gibraltar” in the eyes of its legion of supporters. That said, these results have forced us all to revisit our long-held assumptions about the sustainability of the earning power of these tech leaders.

The immediate market concerns seem to center on the outlook for Amazon and Meta, as Alphabet and Microsoft’s results weren’t really that bad. Some of this differentiation is also evident in the stock market’s reaction to the results, with Amazon and Meta stocks really getting punished following their quarterly reports.

You can see some of it clearly in the chart below which shows the quarterly performance of this group of stocks against the S&P 500 Index.

Image source: Zacks Investment Research

The one thing that becomes clear after the results of these “Big 5 Tech Players” is that none of these players are teflon coated and immune to cyclic forces. Apple may seem invincible following its quarterly report, but the consumer’s decision to buy the company’s expensive phones and other devices remains a discretionary choice and vulnerable to economic forces.

Q3 revenue for the “Big 5 Tech Players” as a whole was down -15.2% from the same period last year, with revenue up +9.4%, as the shows the graph below.

Zacks Investment Research
Image source: Zacks Investment Research

For the whole of 2022, the group should achieve a -13.6% drop in profits on a +5.5% increase in revenues. But growth is expected to pick up next year and accelerate the following year, as you can see in the chart below which shows the group’s profit and revenue growth on a year-over-year basis.

Zacks Investment Research
Image source: Zacks Investment Research

One of the main drivers of the group’s current growth challenge is the general pressure on margins, based on their inflated payrolls, especially for Amazon, Meta and Alphabet. Many in the market have suspected for some time now that these companies are significantly overstaffed, with Amazon even acknowledging the reality. You could say that if they adopt the management style of other blue chip operators by controlling their expenses, they can help boost their profitability.

Amazon hired a ton of workers during Covid to keep up with growing demand as we all stopped going to stores. The question now is whether they should let some of those workers go, as Covid restrictions are mostly in the rear view mirror.

In addition to the group’s margin challenge, there are two other factors that will drive its profitability over the next two years.

The first factor is the unusual impact of Covid on their profitability over the past two years. You can see some of that from the 2021 growth numbers in the chart above. The table below shows the group’s total dollar profits and revenues over the past 6 years and estimates for the next two years.

Zacks Investment Research
Image source: Zacks Investment Research

You can see the unusually large gain in 2021 due to the pandemic. The question now is whether the +58% jump in 2021 earnings has boosted earnings for 2022 only or 2022 and 2023?

The second factor is related to the impact of macroeconomic forces on the profitability of these companies. Microsoft’s business was impacted not only by falling PC demand, a function of post-Covid adjustment, but also by slowing cloud business growth.

We also saw similar cloud-centric challenges in the Amazon and Alphabet reports. This cloud deceleration is likely a reflection of reduced business spending, in addition to containing digital advertising spend.

The market was under the impression that cloud spending was effectively immune to economic forces and would see no reduction. Figures from Microsoft, Amazon, Alphabet and others show otherwise.

That brings us back to assessing the seemingly Teflon-coated status of Apple’s gadgets and services.

My view is that once the tighter Fed policy regime produces cracks in the job market, we will eventually find that consumers have rationally put off replacing their old devices with new ones. We’re not there yet because the labor market is still rock solid, but we could very well reach that point in either of the next two quarterly reports.

The trend of estimate revisions

Analysts have been steadily cutting their estimates for some time now. We have seen this as we approach the start of the Q3 earnings season and the trend continues when it comes to estimates for the current period (2022 Q4) and full year 2023.

The charts below show how earnings growth expectations for the fourth quarter of 2022, as a whole and excluding energy, have evolved over the past few weeks.

Zacks Investment Research
Image source: Zacks Investment Research

The graph below shows how the expected aggregate total profits for the whole of 2023 have evolved excluding energy.

Zacks Investment Research
Image source: Zacks Investment Research

As you have consistently pointed out, aggregate S&P 500 earnings outside of the energy sector peaked in mid-April and have been falling ever since. In fact, earnings estimates for the S&P 500 overall excluding the energy sector have fallen -9.9% since mid-April, with double-digit percentage declines in the retail sectors. , construction, consumer discretionary, technology, industrials and aerospace. In total, estimates are down for 13 of the 16 Zacks sectors.

The overall portrait of earnings

The chart below gives an overview of earnings on a quarterly basis.

Zacks Investment Research
Image source: Zacks Investment Research

The chart below presents the overall earnings picture on a yearly basis, with the growth momentum expected to continue.

Zacks Investment Research
Image source: Zacks Investment Research

It should be noted that a large part of this year’s growth is due to the strong momentum of the Energy sector, whose profits should increase by +142.6%. Excluding this extraordinary contribution from the energy sector, earnings growth for the rest of the index would be down -1.3%. This relatively stable earnings picture for this year is also in line with the economic reality on the ground.

Next year earnings are only expected to be up +3.8% overall and +5.6% excluding the energy sector. This magnitude of growth can hardly be called out of sync with a stable or even slightly declining economic growth outlook. Keep in mind that the overall GDP growth numbers are in real or inflation-adjusted terms while the S&P 500 earnings discussed here are not.

As mentioned earlier, aggregate earnings estimates for 2023 excluding energy are already down -9.9% since mid-April. We may see a few more downward adjustments to estimates over the next few weeks after seeing the third quarter results. But we have nevertheless already gone some way in bringing the estimates to a fair or appropriate level.

This is especially true if the economic downturn ahead of us turns out to be more of the garden variety than the last two such events. Recency bias forces us to use the last two economic downturns, which were also among the most severe in recent history, as benchmarks. But we have to be careful about this natural trend because the fundamentals of the economy currently remain exceptionally strong.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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