To The Moon

Earnings estimates for 2023 look too optimistic, Goldman Sachs says

Equity analysts look too confident in profit margin expansion across the broader market next year, according to Goldman Sachs.

That confidence means consensus S&P 500 (SP500) (NYSEARCA:SPY) $SPDR S&P 500 ETF Trust(SPY)$earnings estimates are likely too high, Goldman strategist Ben Snider wrote in a note Tuesday.

"Looking forward, analyst estimates show S&P 500 profit margins climbing to new highs in 2023," Snider said. "Despite tightening financial conditions, persistent input cost pressures, and slowing revenue growth, analysts continue to forecast a rise in profit margins next year."

"Excluding Financials (XLF) and Utilities (XLU), analyst estimates show aggregate S&P 500 net profit margins expanding by 30 bp in 2023," he said. "The median stock is projected to grow net margins by 60 bp to 14.5%."

Except for Communication Services (XLC), analysts expect the median stock in every sector to show better margins in 2023 than 2021, even with a high chance of recession (Goldman puts it at 50%).

"Aggregate S&P 500 profit margins have declined from peak to trough by a median of 130 bp in recessions since 1970, ranging from an 80 bp compression in 1981 to a 180 bp decline in 2001," Snider said. "Our analysis of equity market fundamentals and performance in past recessions showed a 13% median decline for S&P 500 EPS in recessions since WWII."

"Even outside of recession, analysts usually prove too optimistic about profit margins," he added. "Post-recession recoveries are the exceptions when consensus margin estimates need to be revised higher, and this pattern was repeated in 2021."

"In most years, however, analysts model roughly 50-100 bp of EBIT margin expansion before eventually revising those estimates lower. This is also roughly the magnitude of margin growth currently embedded in consensus estimates for 2023. However ... the outlook for profit margins today looks less favorable than usual."

Goldman recommends companies in Healthcare (XLV), which often sees rising earnings during recessions, and companies with stable earnings growth.