Positive Earnings Backdrop - Ahead of Wall Street

Thursday, April 24, 2014

The strong Caterpillar CAT earnings report this morning and last evening's Apple AAPL and Facebook FB reports provide a favorable backdrop for today's trading action. The Q1 earnings season is front and center today, as we have more than 230 companies reporting results, including 64 S&P 500 members.

We do have a couple of notable misses from the likes of 3M MMM and UPS UPS and the General Motors GM report had a kitchen-sink feel to it. But the Caterpillar report is very reassuring, with the company coming ahead of expectations and raising guidance.

We should  keep in mind, however, that the Caterpillar positive surprise is less a function of an improved global growth outlook and more a result of operational efficiencies. The construction market, particularly here in the U.S., is steadily improving and remains a source of strength for Caterpillar, but they modestly lowered their outlook for the global mining industry. Investors have a positive outlook for capital spending this year and that view likely got a boost from this morning's March Durable Goods report. But it's far from clear at this stage if the hoped-for capex ramp-up will arrive.

Including this morning's earnings announcements through 7:30 CST, we now have Q1 results from 172 S&P 500 members that combined account for 46.4% of the index's total market capitalization. Total earnings for these 172 companies are up +2.1% from the same period last year on +2.8% higher revenues, with 68% beating EPS estimates and 48.8% coming out with positive revenue surprises.

This is weak performance relative to what we have been seeing from this same group of companies in recent quarters. The +2.1% total earnings growth for this group of companies compares to +10.6% in 2013 Q4 and the 4-quarter average of +7.4%. The revenue growth performance is not as materially weaker relative to other recent quarters, but it is a tad on the weak side. With respect to beat ratios, the EPS beat ratio is right around where it was in 2013 Q4 and the preceding few quarters, though the revenue beat ratio is on the weak side.

The primary reason for the weak earnings growth rate is the drag from the Finance sector's -8.6% earnings decline. We should keep in mind, however, that the Finance sector's weak growth numbers are primarily due to Bank of America BAC. Excluding the roughly $2 billion negative swing in Bank of America from the Finance sector's tally, total earnings for the sector would be down only -1.8% and excluding Bank of America from the S&P 500 as whole would push up the aggregate growth rate to +4.5%. Excluding the Finance sector as a whole, total earnings for the remaining S&P 500 companies would be +6.4% on +4% higher revenues, which is actually better than what we have seen from the same group of ex-Finance companies in other recent quarters.

This modest positive aside, there is still plenty that is disappointing about the Q1 earnings. The most notable disappointing aspect of the Q1 earning season thus far is the lack of any improvement on the guidance front. Management guidance has been on the weak side for almost two years now, keeping the revisions trend firmly in the negative direction. We haven't seen any improvement on the guidance front thus far, though it may be a bit premature to lose hope altogether. But the results thus far increase the odds that we wouldn't see any change on that front this earnings season either.

Sheraz Mian
Director of Research