Earnings Roundup: Gap Widens Between Earnings “Beats” and Revenue “Beats”
The rate at which S&P 500 companies are reporting positive surprises may reassure investors, but it’s accompanies by the lowest revenue “beat rate” recorded in more than three years.
Midway through the second-quarter earnings season, a healthy proportion of companies in the S&P 500 index have managed to post positive earnings surprises. Instead, some of the weakness in the underlying economy is showing up in a different area, as a far smaller number of those companies are managing to beat analysts’ estimates when it comes to their revenues.
In a typical quarter, 63% of S&P 500 companies beat revenue forecasts, while the long-term earnings beat rate is around 62%. As of the end of last week, with 294 companies having reported their results, 67% have posted positive earnings surprises, while only 40% have beaten their revenue forecasts. If the revenue beat rate remains at this level, it will be only the fourth time in the last ten years that fewer than half of S&P 500 companies have posted positive top-line surprises. This gap between revenue and earnings beat rates – wider than it has been since the first quarter of 2009, and one of the widest seen in the last decade – serves as a reminder that during earnings season it’s important to look beyond the earnings-per-share results before concluding that the quarter has been successful in terms of corporate profits. Recognizing that this gap exists, that it appears to have widened in recent months, and understanding the reasons it is the size it is, can provide investors with even more insight into how companies are generating their earnings.
As we learned last week, even stalwart companies like Apple (AAPL.O) are able to report revenue figures that fall short of expectations. Indeed, weak revenues from Europe led Apple to report the largest negative revenue surprise for the quarter among S&P 500 companies last week. Although its sales were 24% higher than in the year-ago quarter, the total fell short of estimates by some $2.15 billion. (Oh, and it also failed to deliver what analysts and investors were looking for when it came to earnings, as we discussed last week.)
Apple is far from alone, alas. McDonalds (MCD.N) also struggled to boost its revenues in the midst of a difficult economy, especially in Europe, where austerity policies have reduced consumer confidence. “We’re experiencing stronger headwinds on both the top and bottom lines,” the company’s CEO, Don Thompson, admitted during the earnings conference call. The fast food chain announced earnings that fell short of estimates for the first time since 2004; revenues grew only 0.2%, to a level below analysts’ forecasts. United Parcel Service (UPS.N), widely viewed as a barometer for economic activity, also reported revenue and profits that fell wide of the mark, even though the company did manage to increase its margins by 50 basis points from the year-earlier period, a particularly noteworthy accomplishment in view of the fact that its revenues grew only 1.2%. “The biggest driver … is slow demand in the developed world,” said Scott Davis, the company’s CEO, during the conference call that followed the earnings announcement. “Frankly Europe and the U.S. both have low demand right now.”
When pondering how many companies beat estimates – whether earnings or revenue estimates – it is important to take into account just how aggressive those initial forecasts were in the first place. For instance, if analysts were expecting to see big gains in revenues, it is possible for companies to report actual results that fall well short of that level and still be viewed as generating solid growth. Unfortunately, that’s not the picture that this quarter’s results paint of corporate revenues. At the beginning of earnings season, analysts were anticipating that S&P 500 companies, collectively, would report revenue growth of 1.7% — not an outrageously bullish forecast. But as the reporting period has progressed, downward revisions brought that figure to a mere 0.8%. Being unable to clear such a low bar would be a worrying sign. (While the quarter-to-date results remain incomplete, the actual figure today is 2.9%.)
The lower the expectations, the better the results, as data from the energy sector suggest. At the outset of earnings season, analysts were forecasting that companies in the Energy sector of the S&P 500 would report a 14.4% decline in revenues. Despite having the lowest growth expectations, the group has posted a 57.1% revenue beat rate. On the other hand, Industrials boasted one of the highest initial growth estimates, with analysts projecting revenue growth of 6.4%. Only 25.6% of companies in that group have beaten those expectations. The same pattern remains intact across all S&P 500 sectors, with the correlation between revenue growth estimates and beat rates remaining strongly negative, at -0.38.
The economic recovery appears fragile, and the world economy appears to be stuck in a period of slower growth. That may well continue to put downward pressure on revenues, resulting in lower gains or even declines in the top line at many U.S. companies. Given that backdrop, investors will want to continue monitoring what happens to corporate top lines as well as to profits during the final weeks of this earnings season and into the third and fourth quarters. Higher profits accompanied by flat to lower revenues means that a company is relying on cutting costs to boost earnings – and there may well be limits to the costs that can be cut in order to maintain margins without harming future growth. Some companies already may have crossed the line and reached the point where they are sacrificing future revenues in order to maintain profits; they may find that the task of generating future revenues and profits becomes more difficult as growth becomes more elusive.
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