Will the Q3 Earnings Weakness Last?

Zacks

We are in the thick of the third quarter reporting season, with a barrage of earnings reports coming out every day. As of Friday, October 19th, we have results from 115 companies in the S&P 500 or 20.4% of the index’s total membership.

Total earnings for these companies are down 2.8% from the same period last year, with only 54.8% of the companies beating earnings expectations. Total revenues are up 1.3% from the same period last year, but only 33.9% of the companies are coming ahead of revenue expectations.

The Tech sector is standing out for its weakness this time around, as we have seen in reports from Intel (INTC), IBM (IBM) and Google (GOOG). The 23.2% of Tech sector companies that have already reported results account for 41.7% of the sectors’ total earnings. Total earnings for these Tech companies are down 10.9% from the same period last year, which compares to a modestly positive growth rate for the same group in the second quarter.

Keep in mind, however, that Apple (AAPL) -- which accounts for roughly a fifth of the sector’s total earnings -- has yet to report results. If the rest of the Tech sector earnings (including Apple’s) come in-line with current expectations, then total third quarter earnings for the sector would be down 1.2% -- a sharp reversal in what we have consistently been seeing from Tech for a while.

Given how tentative guidance has been thus far, it doesn’t look like we will see a trend reversal in the fourth quarter. But that’s what current consensus estimates means.

The expectation is that after a weak third quarter, earnings growth will resume in the fourth quarter and beyond. I am skeptical of this notion and expect significant downward revisions to current expectations in the coming days. The question is whether Mr. Market will ignore those negative revisions or finally start taking note.  

Key Points

  • The third-quarter 2012 reporting season is in full swing, with results from 115 companies in the S&P 500 already out. Overall results are weaker than what these companies produced in recent quarters.
  • Total earnings  for these companies are down 2.8% from the same period last year, with only 54.8% of the companies beating earnings expectations. Total revenues are up 1.3%, though only 33.9% of the companies have come out with positive revenue surprises.
  • The Tech sector has been very weak thus far as reports from Google, Microsoft (MSFT), Intel and Intel show. Total earnings for the 23.2% of sector companies that have already reported are down 10.9%, with only 37.5% of them beating earnings expectations.
  • The Finance sector has the best performance thus far, though the subdued earnings growth rate for the sector (up 0.3%) is solely due to the negative comparison for Bank of America (BAC).
  • Basic Materials and Energy are the weakest thus far, though both sectors have a lot more reports to come in the coming days.   
  • Total earnings for the remaining 385 companies, or roughly 77% of the total, are expected to decline 2.3, reflecting a roughly equivalent revenue drop and flat margins.
  • The composite earnings growth rate, combining the reports that have come out with those still to come, for the third quarter is for a decline of 2.2% for the S&P 500 as a whole, and a decline of 6.5% excluding Finance.
  • The composite Tech sector earnings growth rate is for a decline of 1.2% from the same period last year, a major reversal of the persistent strong growth for a long time. Excluding Apple, which accounts for about 20% of the sector’s earnings, total Tech sector earnings would be down 6.3% vs. positive 2.1% growth in the second quarter.  
  • Unlike expectations for the third quarter, estimate for the following quarter remain quite strong, with total earnings expected to be up 7.3% in the fourth quarter. Of the 9 sectors that are projected to have negative year over year comparisons in the third quarter, 8 are expected to turn positive, with Basic Materials and Autos as the most prominent. Energy becomes far less of a drag in the fourth quarter.
  • Net margins are expected to be flat in the third quarter, both year over year as well as sequentially. Eleven of the 16 sectors are expected to see margins contract in the third quarter, including Tech. Excluding Finance, net margins would be down 50 basis points from the same period last and roughly flat from the second quarter. But margins are expected to improve back up in the fourth quarter.
  • Total earnings for the full years 2012 and 2013 are expected to be up 5.6% and 11.3% respectively. Revenues are expected to be essentially flat this year (up only 0.1%), but up 4% in 2013.
  • The bottom-up ‘EPS’ estimates for 2012 and 2013 -- reflecting projections of analysts at brokerage firms covering individual companies -- currently stand at $102.95 and $114.91, respectively. The top-down estimates -- reflecting the projections of strategists at brokerage firms -- currently stand at $101.79 and $108.95 for 2012 and 2013, respectively.
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