Earnings season is upon us once again. In a few days, U.S. public companies will start to present their figures for the most recent quarter. I have taken a look at analysts’ forecasts and their pitfalls for you.
U.S. Earnings Season Estimates Have Their Pitfalls
Before we get into the data, I want to make you aware of a few things you should always keep in mind when looking at earnings estimates:
- Analysts who publish earnings estimates are almost always employees of financial services firms which are always looking to increase assets under management. This can incentivize them to publish more positive estimates than are actually realistic. After all, who would want to invest money in stocks when the outlook is negative? Studies show that analysts’ annual earnings estimates are usually around 30% higher than actual, real-world results.
- Analysts are NEVER held accountable for the accuracy of their forecasts. Therefore, they basically do not care whether they are right or wrong.
- There is a noticeable tendency to significantly lower the more optimistic forecasts in the run-up to an earnings season. This increases the probability that a company exceeds expectations.
A fourth point should be added today: The economy can change rapidly, and forecasts often change with it. Goldman Sachs (NYSE:GS) offers a good example of this. In their Global Investment Research Report, Goldman analysts provide a monthly outlook on how they expect U.S. inflation to change in the current year and the next three years.
Since inflation data are always published in the middle of a month, I have entered the Goldman Sachs forecasts in yellow below the previous month’s value. (For example, the bar with the core inflation rate for March (published in April) shows you the Goldman Sachs forecast for April 2021.)
As you can see, the analysts have more than doubled their estimates for the core inflation rate in just 5 months.
Last Earnings Season: Estimates vs. Reality
In early August, economists predicted that we had seen the peak of U.S. earnings growth in Q2 2021.
The revenues of S&P 500 companies collectively climbed by a staggering 25.3% in Q2, while earnings climbed by an even-more-impressive 95%! Of course, the extremely low starting point of the previous year (the midst of the COVID-19 recession) helped boost those growth numbers.
Analysts’ forecasts for Q3 and Q4 were significantly lower 2 months ago: sales were expected to grow by just 10% to 13%, and profits were expected to grow only 21% to 26%.
Are the Analysts too Optimistic?
At the beginning of the year, analysts’ outlooks were still clouded by the events of 2020. U.S. COVID-19 vaccines had just been granted emergency approval, and the pace of economic recovery was uncertain. At that time, they expected an average increase in corporate profits of 13.5% for Q3. At the end of June, forecasts were already at 22%, before rising to 26% in August.
Since then, however, there have been only marginal adjustments. Currently, analysts expect corporate earnings to improve by an average of 26.1%. They’re also forecasting 20.2% earnings growth and 10.5% sales growth for Q4.
The big question is: has heavy inflation already impacted U.S. corporate earnings performance? Due to dysfunctional post-pandemic global supply chains, manufacturing costs have skyrocketed – and inventories of industrial inputs have emptied.
There is an immense shortage of electronic components and semiconductor chips, for example. The auto industry in particular is suffering from this; they’re delaying the production of entire models.
As we’ve discussed, earnings estimates for Q3 have not been lowered in the last few weeks. This unusual situation could lead to a lot of disappointed investors if the analysts were too optimistic.