To The Moon

2022 Q3 earnings season's coming, Will it be another growth season?

As of October 10, the $S&P 500(.SPX)$ is expected to report (year over-year) earnings growth of 2.4% for the third quarter, which would be the lowest earnings growth reported by the index since Q3 2020. $SPY(SPY)$

Based on the average improvement in earnings growth during the past few earnings seasons due to companies reporting positive surprises, it is likely the index will report earnings growth between 6% and 7% for Q3.

Why the actual value can be as high as 7% while the market consensus only 2.4%?

In fact, the actual earnings growth rate has exceeded the estimated earnings growth rate at the end of the quarter in 39 of the past 40 quarters for the S&P 500. The only exception was Q1 2020, which was the start of pandemic.

Data source: Factset

According to the data of the past 10 years, the year-on-year growth rate of real earning in a single quarter which exceeds the consensus growth rate is expected by the market by 5.5 percentage points on average, that is, with the consensus growth rate of 2.4% on Q3, the actual growth may reach 2.4% +5.5% = 7.9%.

While ince 2020, the actual profit growth rate in a single quarter has exceeded the expected average by 4%. Therefore,Even with the consensus growth rate of 2.4% after the pandemic, the Q3 growth rate of S&P 500 may reach 2.4% +4.0% = 6.4%.

Therefore, although the consensus of Q3 market expectations is on the bright side, the profit growth rate of S&P 500 will still be considered priced-in a growth rate of 6-7%.

What is the expectation of Q3 for the company giving the guidance?

Of the more than 500 companies in the index, only 106 gave Q3 earnings guidance. Include $Apple(AAPL)$. 

Of these companies, 65 have issued negative EPS guidance and 41 have issued positive EPS guidance. Instead, the profit guide plays the role of "profit warning". Among the companies that give positive profits, the number of companies issuing positive EPS guidance is above the 5-year average of 39 and above the 10-year average of 32.

Data source: Factset

As more and more companies report quarterly thunder this year (including$Netflix(NFLX)$,$Meta Platforms, Inc.(META)$Such a head enterprise), companies pay more and more attention to the "expected management" of the market. The market is rewarding S&P 500 companies issuing positive EPS guidance for Q3 more than average while also punishing S&P 500 companies that issue negative EPS guidance for Q3 more than average. 

Companies that have issued positive EPS guidance for Q3 have seen an average price change of +3.1% two days before the guidance was issued through two days after the guidance was issued. On the other hand, companies that have issued negative EPS guidance for Q3 have seen an average price change of -2.2% two days before the guidance was issued through two days after the guidance as issued.

Data source: FactseT

The most important factor that can not be ignored in 2022

Currency.

As the S&P 500 companies use the US dollar as the currency of financial report, the company's performance will be affected by the strong US dollar to some extent in 2022, when the US dollar index reaches a new high. Among the S&P 500 companies, 40% of their business income is exposed to the non-US dollar market.

Data source: Factset

Different from the supply chain problems caused by inflation and rising labor costs since the second half of 2022, exchange rate changes have a very direct impact on corporate profits. In the past five quarters, a growing number of companies reported earnings in the first week of the year, mentioning the headwind impact of foreign exchange on corporate earnings.

What is the current valuation level of the S&P 500 index?

As of October 10th, the P/E ratio of S&P 500 TTM was 17.7 times.

Relatively comparing(within 5 standard deviations), in the past 5 years, only the months of the pandemic in 2020 were lower than now. This is almost a return to the level during the European debt crisis in 2012.

With the announcement of Q3 and Q4 earnings seasons (with an expected growth rate of 7%), At the end of 2022, the forward P/E ratio will drop to 15.5 times. If we look at the current index price, the forward P/E ratio in 2023 and 2024 will further drop to 14.87 times and 13.69 times.

Different from the period in 2012, the Price-to-sales rate calculated by income index is still above the 10-year dynamic average, while the market-to-cash rate calculated by cash flow index is also near the 10-year dynamic average.

This means cost play a pivotal role in enterprise profis.

Once the headwind factors on the cost side are eliminated, the P/E ratio of the S&P 500 may decrease "beyond expectations", and then there will be a better turning point.