The end of the first calendar quarter in March brought on an earnings reporting season that held the potential to strongly influence market direction for the coming months. As we know, stock prices are influenced less by what a company did, than by what a company is expected to do with respect to profits. Accordingly, companies not only provide past results in their quarterly earnings reports, but also guidance on what they see ahead. As we review results, it is always with an eye toward the future, and that is part of how we inform decisions on investment strategy. Now that the reporting season is behind us, let’s look at the results, and what they may mean as we go forward.
At the end of the first quarter this year, concerns over profitability in general, and more specifically profit margins, were at the forefront of many investors’ minds. With energy prices rising, inflation in general, and the war in Ukraine, forecasting the profitability of companies in the quarter was especially challenging.
Despite the trepidation of many market participants this year, the profit results for Q1 were actually better than expected for the most part. Overall, 77% of companies reported earnings results that were above analysts’ average estimates. That is in line with the 5-year average for companies beating estimates. However, those 77% of companies exceeded estimates by an average of 4.7%, which is well below the 5-year average beat of 8.9%. So, while the same percentage of companies beat estimates, they didn’t exceed estimates by as much as they had historically.
The market reacted quite negatively to this news. In fact, between the two days prior to a company releasing results to the 2 days after, stock prices reacted negatively on average. According to FactSet, the market had the largest negative reaction to positive earnings reported by S&P 500 companies for a quarter since Q2 2011.
So, why would this occur? One explanation may be the fact that the percentage by which companies exceeded estimates was smaller than average. Some reports have cited supply chain issues and labor shortages as headwinds to growth. In addition, we think that the general impact of inflation through higher raw material costs and higher transportation costs has caused pressure on margins. The question is whether this will persist or is it a shorter-term issue.
At this time, analysts seem to believe that things will stabilize for the second half of 2022. While earnings projections for Q2 have been revised downward, estimates for the second half are actually being moved up slightly. As of May 20, “the bottom-up EPS estimate for the third quarter increased by 0.4% (to $59.52 from $59.26) from March 31 to May 31, while the bottom-up EPS estimate for the fourth quarter increased by 0.2% (to $60.78 from $60.74) during this same period” according to FactSet. Beyond this year, analysts are even more sanguine, having raised 2023 projections during the first two quarters of this year, despite the market having moved down in that same period.
As we certainly face multiple issues that the market will have to digest in the coming months and quarters, longer term we remain constructive.
We would remind investors of the forward-looking nature of markets and cite the spring and summer of 2020. In a time when nobody had a clear picture of what was to come, and the COVID-19 situation was particularly dire, that stock markets seemed to be looking past the current challenges. A review of an S&P 500 chart reveals how strongly markets can recover and did during that volatile time. We would suggest that investors keep their eye on the horizon rather than the headlines, and invest for the future, not for the day.
If you have any questions about this or any personal financial matter, please feel free to contact your Atlas Wealth Management Advisor. We always look forward to serving our valued clients.
1 – FactSet Earnings Insight, May 20, 2022 – S&P 500: Largest Negative Price Reaction to Positive EPS Surprises Since 2011
2 – FactSet, June 3, 2022 – Analysts lowering EPS estimates for Q2 2022 but not lowering EPS estimates for 2H 2022
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