-
""

US earnings growth expectations too low

16 May 2019

As the first-quarter earnings season comes to an end, we believe it makes sense to step back from all the geopolitical noise and focus on what really matters over the medium term: companies’ performance.

From the start we felt that US consensus’ earnings growth expectations (-2%) for the first quarter were low in the context of healthy revenue momentum (+5%). With 90% of companies having reported, it appears that the market’s cautiousness was indeed unjustified. Three-quarters of companies have delivered better than expected earnings, surprising by an average of +6%, and leaving the year-over-year growth rate at +1.3%. While this may seem low at face value, one should remember it comes on the back of a strong comparable figure (+26% growth in the first quarter of 2018), courtesy of tax cuts.

In Europe, with half of the companies reporting profits only on a semi-annual basis, it is difficult to draw any conclusion at this stage. But from a revenue perspective at least, growth appears positive.

So all in all, it appears that companies have been able to grow revenue, preserve margins and increase earnings in the first quarter of 2019. Unfortunately, this backward-looking statement has little influence on a forward-looking market like equities. Focusing on the consensus’ expectations and companies’ guidance may be more helpful when trying to anticipate future performance.

The projected outlook

At first glance, the outlook is more mixed. First, negative pre-announcements for the second quarter remain elevated with 77 companies cutting projections versus 15 maintaining them. This suggests that second-quarter growth expectations (+1.1%) could see further downward pressure in the short term. Second, full-year projections (+3%) remain broadly unchanged, suggesting that investors — and most companies — anticipate a re-acceleration in the second half of the year. Although not completely unrealistic, this scenario remains uncertain, especially in the context of growing trade tensions.

Yet, we maintain our view that consensus’ earnings numbers are too low and see three main drivers for positive surprises (and upgrades) ahead:

  • First, US companies have demonstrated an ability to protect margins. Looking at the first quarter versus the same period last year, the majority of companies (ie 52%) in the S&P 500 Index have increased their net-profit margins. Despite headwinds coming from raw materials, labour costs and tariffs, companies have safeguarded profitability via a combination of increased efficiency, operating leverage and price hikes. We see no reason for this to change materially in the next 6-9 months and so more of the revenues should flow through to earnings.
  • Second, we expect continued buyback activity. After purchasing more than $800 billion worth of their own shares in 2018 (up 55% versus 2017), we believe US companies can continue reducing their share count at a healthy pace thanks to a war chest of more than $1.4 trillion. This should support earnings growth to the tune of around 2 to 3% annually.
  • Finally, we expect company executives to manage expectations so that they can deliver good news when reporting. This is particularly important at the end of the cycle when investors are on the lookout for any indication that the worst may be about to happen. This is why companies that have reported negative earnings surprises for the first quarter have seen an average share price decrease of -3.5% between two days before the earnings release and two days after the earnings release. This is much larger than the 5-year average price decrease of -2.5%. The average earnings surprise for the S&P 500 is around 5%. It was above 6% in the first quarter and we would expect it to remain elevated throughout the year.
S and P 500 quarterly buybacks

Geopolitical noise will inevitably surface from time to time. But medium-term investors should look past it. The real focus for any equity investor (as opposed to a trader) should be earnings and whether companies can grow them. We believe they can.

Related articles

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This document has been issued by the Investments division at Barclays Private Banking and Overseas Services (“PBOS”) division and is not a product of the Barclays Research department. Any views expressed may differ from those of Barclays Research. All opinions and estimates included in this document constitute our judgment as of the date of the document and may be subject to change without notice. No representation is made as to the accuracy of the assumptions made within, or completeness of, any modeling, scenario analysis or back-testing.

Barclays is not responsible for information stated to be obtained or derived from third party sources or statistical services, and we do not guarantee the information’s accuracy which may be incomplete or condensed.

This document has been prepared for information purposes only and does not constitute a prospectus, an offer, invitation or solicitation to buy or sell securities and is not intended to provide the sole basis for any evaluation of the securities or any other instrument, which may be discussed in it.

Any offer or entry into any transaction requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding transaction documents. Any past or simulated past performance including back-testing, modeling or scenario analysis contained herein does not predict and is no indication as to future performance. The value of any investment may also fluctuate as a result of market changes.

Neither Barclays, its affiliates nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation..

This document and the information contained herein may only be distributed and published in jurisdictions in which such distribution and publication is permitted.  You may not distribute this document, in whole or part, without our prior, express written permission. Law or regulation in certain countries may restrict the manner of distribution of this document and persons who come into possession of this document are required to inform themselves of and observe such restrictions.

The contents herein do not constitute investment, legal, tax, accounting or other advice. You should consider your own financial situation, objectives and needs, and conduct your own independent investigation and assessment of the contents of this document, including obtaining investment, legal, tax, accounting and such other advice as you consider necessary or appropriate, before making any investment or other decision.

THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.