Fourth-quarter earnings season is here: A closer look

A perspective from E*TRADE Securities1

01/25/19

We’ve heard the punditry, the premonitions, and the prognostications. Now let’s see the results.

Fourth-quarter earnings season is in full swing and all eyes are on the beats and misses that, when taken as an aggregate, will help set the tone for the markets in 2019.

Given the crosswinds of a strong economy and numerous headline risks, investors will be tracking earnings with especially watchful eyes this time around. Are signs of a late-stage economy premature? How much damage have tariffs exacted on US manufacturers and commodity exporters? Did retailers ring up a holiday bonanza? Are the days of super-sized growth within the tech sector behind us?

These are just some of the questions investors will want answered as corporate chieftains take to speakerphones all across the land.

The envelope, please    

Granted it’s early, but so far, the results are a bit like your favorite pizza joint under new ownership: They still make a good pie, but it doesn’t have the zip you’ve come to expect.

According to FactSet, with just 11% of S&P 500 constituent firms reporting, 76% have reported positive earnings per share (EPS) surprises, while 56% have reported positive revenue surprises.1 In the first half of 2018, roughly 80% of S&P constituents beat earnings estimates, so earnings beats are down modestly since then, but they remain above their five-year average.2

S&P 500 2018 earnings and revenue scorecard

Source: FactSet Research Systems


Expectations for the first half of 2019 are an entirely different story. In recent months, analysts have delivered the largest cuts to first-half EPS estimates in four years.1
S&P 500 revisions to first-half EPS estimates

Source: FactSet Research Systems


Some other notable takeaways in the early innings:

Large financial firms are posting solid results

Goldman Sachs and Bank of America both saw their shares surge after beating estimates for fourth-quarter EPS. Given the drubbing that financials have taken of late, that should be encouraging to value investors.

Lending is only a small part of Goldman’s business, so its results aren’t necessarily representative of financials as a whole. But Bank of America’s record quarterly profit was driven in part by the strong performance of its consumer-lending unit and rising net interest margins—a closely watched barometer of bank profitability. Wells Fargo and Citigroup also topped expectations.

Some tech bellwethers companies are performing well but not well enough

Often, what appear to be positive results can be construed as just the opposite by investors.

Take Apple, for example. Last November, the consumer electronics giant posted fourth-quarter revenue of $62.9 billion—an increase of 20% from the previous year. Apple was also increasingly profitable, growing earnings per share by 41% on a year-over-year basis and setting a number of sales records.

For all that, Apple shares sold off by more than 9% after the company released earnings.

To seasoned investors, the reason was obvious. Guidance. Although Apple reported stellar financial results, it also lowered its first-quarter earnings guidance to roughly $84 billion—$5 billion below the low end of previous estimates. All this being said, Apple has proven to be a formidable competitor, so while it may have been perceived to be down, it’s certainly not out. Investors may be scooping up shares at a bargain.

Adobe and Netflix also traded lower after posting solid fourth-quarter results that failed to impress—lower-than-expected earnings in the case of Adobe and a revenue miss for Netflix.

To the extent that these “disappointments” reflect broader trends in technology, investors could have reason for concern. Even though Apple, Netflix, and Adobe are generating lots of cash, sometimes companies can be victims of lofty expectations and their own past successes.

Key themes to watch  

•  Expectations matter as much as quarterly results. Even the most profitable companies can sell off if revenue or earnings guidance is lowered.

•  Keep an eye on large multinationals. These are the firms that depend disproportionately on exports for revenue and are the most likely to be hurt by tariffs enacted in 2018. Earnings misses traced to rising import costs from tariffs could be a harbinger of trouble for large caps—especially if little progress is made on trade deals.

•  Energy firms also bear watching. Crude oil futures have shown signs of life after getting battered last year on rising supply and concerns about global growth. While many analysts are skeptical that oil can continue to move higher, a strong global economy could go a long way toward supporting energy shares.

•  Also, you don’t necessarily have to be discouraged by potential earnings setbacks, as most economic fundamentals are still sound and there are still attractive valuations to be found. In fact, the forward price-to-earnings ratio for S&P 500 firms is near its lowest level in five years.

Earnings season is always important, but this year it seems to hold even deeper significance given so many conflicting economic signals and the recent federal government shutdown. Ultimately, though, how Wall Street reacts to the quarter that ended will hinge in large part on expectations for the quarter to come.

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