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Three Things We Learned from the Third Quarter Earnings Season

Most of the third-quarter earnings season is over, with the results of more than 85% of S&P 500 companies having been released.

With real quarterly reports disproving pre-season worries of an approaching “earnings cliff,” the general impression from the third quarter results season was one of relief and reassurance. We have been clear that the picture that emerged from the third quarter earnings season was not ideal, but it wasn’t terrible, either. Here are three takeaways from the third-quarter earnings season.

The first is: Growth is fading.

Several factors, including rising interest rates in reaction to inflationary pressures, easing logistical difficulties, and China’s continued zero-Covid restrictions, have contributed to a synchronised slowdown in economies around the world.

An increase in sales is depicted by the orange bars in the above graph. For the third quarter of 2022, revenues are projected to increase by 11.3% year over year, while earnings are forecast to increase by only 1.6%. The ability to pass on higher input costs to end consumers is a key cause of this seemingly accelerated revenue growth. We have a gut feeling that this can’t keep up indefinitely, and the forecast for the next three months supports that.

The Second is: Margins are holding up better than most of us would have expected.

The last three quarterly net margins have been lower than the same period a year ago, but the challenges aren’t being felt uniformly across industries.

Net margins for the 429 S&P 500 companies are down 130 basis points in aggregate based on third-quarter data, with 10 of the 16 Zacks sectors experiencing margin contraction. As a counterpoint, four industries saw improved margins when compared to the same time last year, with Energy seeing the greatest improvement.

The technology, basic materials, and banking industries are feeling the effects of the margin pressure the most. Last week, we talked about the earnings forecast for the technology industry as a whole, and for the “Big 5 Tech Players” in particular: Apple, Amazon, Alphabet, Microsoft, and Meta. For more, check out Analyzing the Impact of Amazon and Meta Tumble on Big Tech Profits.

In that letter, we mentioned how each of these Tech titans had been in a wild dash to hire new staff members over the past year and a half, resulting in excessive payroll costs. Both Meta and Amazon are predicted to have net margins this year that are well below the 2021 target by large margins (1274 and 586 basis points, respectively).

This margin problem is not unique to the so-called “Big 5 Tech Players,” but rather affects the whole technology industry.

The Third is: The narrative that earnings estimates remain too high is misleading if not altogether wrong.

If you’ve been following our results commentary, you know that we’ve been warning about the steady decline in projected earnings over the next few months.

Since they are crucial to our stock-rating system, any changes in earnings forecasts are treated with great gravity. From what we can tell, the earnings forecast for 2023 outside of the Energy sector reached its high point in April and has been falling steadily ever since then.

Earnings forecasts for the S&P 500 index as a whole have decreased by -7.4% since mid-April and by -10.4% when excluding Energy companies. Tech has seen the largest drop in projections (-17.4 percentage points) among all industries since mid-April, followed by construction (-21.5%), retail (18.2%), industrial products (-11.8%), consumer discretionary (-15.1%), and aerospace (-11.8%).

Comparing Amazon and Meta, during the past three months, analysts’ predictions for Amazon’s 2023 profits have dropped by -19.8% (from $21.7 per share to $1.74 per share) and by -30.4% (from $11.15 per share to $7.76 per share).

In light of this, we stand by our earlier assessment that the story of the changes is inaccurate, at best. As we mentioned before, estimates have been dropping steadily and have dropped by more than 10% since mid-April, when compared to a scenario without Energy.

Some investors believe that, given expectations for a modest recession in the U.S. economy, earnings in 2023 should be lower than in 2022, rather than the +3.5% growth that is now projected.

Microsoft, Apple, Alphabet, Meta, and Amazon

Please don’t misunderstand me; I’m not saying that 2023 profits won’t be lower than 2022 profits; they can be, and the trends in earnings revisions imply that they will be. A moderate drop in real GDP, however, should not be seen as an indication that ‘nominal,’ or non-inflation adjusted, company earnings will likewise fall.

Nominal numbers, such as those used in reporting a company’s revenue and profit, are adjusted for inflation. The rate of inflation is predicted to slow in 2023, but remain in positive territory. Profitability in Q3: A Progress Report

Results for the third quarter are in for 429 of the S&P 500 companies, or 85.8% of the total, as of this past Friday, November 4th.

Large-cap firms that make up the S&P 500 index have mostly finished reporting their quarterly profits. However, many smaller and medium-sized enterprises have yet to release their quarterly financial reports. Over a thousand companies, including thirty from the S&P 500, will release their quarterly results this week.

To date, 429 members of the index have declared their financials, revealing an increase in earnings of +2.2% year-over-year on top of +12.4% higher revenues. Furthermore, 70.9% of these companies have surpassed EPS predictions and 67.8% have surpassed revenue forecasts.

Here we examine the profits and revenue growth rates of 429 firms over various periods beginning in the third quarter of 2022.

Early in the reporting season, the EPS and revenue beat percentages were noticeably low. Above, you can see that they are now well within the norm for this period.

For a detailed look at the overall earnings picture, including expectations for the coming periods, please check out our weekly Earnings Trends report >>>>Breaking Down the Earnings Picture as Estimates Fade

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