Idea of the Week: Analysts Cutting Their Q3 Revenue Forecasts

September 12th, 2012 by

Already, it is clear that companies in the S&P 500 companies are likely to post the slowest annual revenue growth rate in the last decade (barring the 2008/2009 financial crisis) and the trend seems to be getting worse, with more disappointments in store.

Released: September 12 2012
Length: 3 Minutes

Two quarters of corporate earnings are behind us for 2012; only weeks from now, companies will begin to disclose their third-quarter results. Earnings growth rates for S&P 500 companies seem to have held their own on a year-over-year basis during the first half of the year, but we’re seeing trouble ahead for both profits and, as we have previously reported, for top-line revenue growth A struggle on the part of the largest U.S. companies to generate revenue growth could ultimately push more investors back into the “risk off” trade.

Earnings growth during the second quarter was stuck firmly in the single digits, as seen in the S&P 500 data in the chart below calculated by Greg Harrison at Thomson Reuters Proprietary Research. (He has aggregated all analyst estimates for earnings and revenues, and then calculated their resulting growth rates.) The red boxes, below, show that in the first two quarters of 2012, year over year earnings rose by 8.1% and 8.4%, respectively.

Figure 1.

One concern about the third quarter is that Harrison’s calculations show that analysts are expecting earnings to decline by 2% for S&P 500 companies for the period. Fourth quarter growth estimates are still positive – the forecast is for 10.3% — but that forecast has already been cut back significantly from the 16.3% estimate recorded in April. The downward momentum continues.

Figure 2.

Analysts started cutting these Q4 forecasts after Q2 earnings started rolling in. If third-quarter results start off on a weak note around mid-October, expect analysts to further chisel away at their Q4 estimates.

Companies can make adjustments to their costs in order to post better-than-expected earnings, at least in the short term. But the shrinking growth rate in top-line revenue is another issue; they can’t cut their way to earnings growth forever. Maybe that’s the reason analysts now have a negative Q3 earnings forecast.

The chart below shows the actual rate of quarterly revenue growth for companies in the S&P 500 (represented by the red bars in the chart below) as well as recent analyst projections (represented by the blue bars), along with the actual price return of the S&P 500 index (green line). This year’s second quarter revenue growth was only 0.8% higher year over year and has been steadily shrinking since hitting its peak in the second quarter of 2011. The market declined in 2007 ahead of the drop in revenue growth, which started in the third quarter of 2008. Could the market remain higher on the hope that things will be turning around? The fact that the S&P 500 has risen so much, and that the Dow Jones Industrial Average has reached its highest level since December 2007 this week despite the decline in corporate revenue growth rates, is a puzzle to which we have yet to find a clear solution.

Figure 3.

The current revenue growth projection for Q3 (please see the purple bars – the fact that they are barely visible is a signal of what’s happening) shows that analysts expect a revenue decline of 0.1% for the S&P 500 companies. And, as mentioned before, analysts tend to wait until the end of the year to see as much data as possible, and then will lower their forecasts as they see necessary. So, as we approach the end of the year, that Q4 estimate of 2.3% revenue growth may be whittled down as well.

While the U.S. economy may not be stalling just yet, this flattening out of revenue growth rates could get more people cheering for the prospect of further stimulus measures by the Federal Reserve, and perhaps even by the central government. This has supported stock prices in the past, but that was in the wake of a 42% plunge in share prices. This time, the impact on stocks may be different. And as we receive further reports from around the world that economic growth is still slowing, a global downturn may just chase away those who got into the risk-on trade on the basis of ECB president Mario Draghi’s pledge to “save the Euro at any cost.”