It is not all that surprising that second quarter S&P 500 corporate earnings growth is turning out to be much better than what was expected at the start of earnings season (0.02% vs -4.45% initially). The overall trend of beating initial consensus earnings estimates has been in place as long as S&P Capital IQ has been collecting data. Over the last five years, reported results have ended up exceeding initial expectations by nearly 400 bps.
Despite the outsized beats recorded the first half of 2015, analysts have consistently put downward pressure on second half earnings estimates. In other words, as the old adage goes, we appear to be robbing Peter to pay Paul. Part of this can be attributed to cautious guidance from corporate management teams in response to heightened uncertainty relating to the global economic environment, commodity prices, and foreign exchange (FX) rates.
Third and fourth quarter 2015 earnings growth rates have declined by a combined 450 bps since second quarter earnings season kicked into gear in mid-July. That sentiment has been carried forward into 2016. At the start of the second quarter, what is now the current forward 12-month period (using Q3 2015 though Q2 2016 estimates), the consensus earnings projection stood at $126.03 per share for the S&P 500, representing growth of 8.6%. Forward expectations have now been reduced sharply to $122.42 and a 3.0% growth rate as of August 19.
NTM (based on Q3 2015 – Q2 2016) S&P 500 EPS and Growth Progression
The S&P 500 Index has traded in a fairly tight range for the majority of the year, between 2,050 and 2,130. Thus, as earnings estimates moved lower, we initially saw the forward price-to-earnings (P/E) ratio expand to 17.8x. More recently, the multiple has returned to near 17x. While the current multiple isn’t anywhere close to the all-time high of 27.0x from the tech bubble, it is also not too far from the 15-year average of 16.0x, suggesting that the prospect of healthy earnings growth over the balance of 2015 and extending into 2016 should make the current 17.0x multiple easier for investors to digest.
Please see our report titled “Robbing Peter to Pay Paul…” published August 19, for a more detailed analysis, including a breakdown of the sectors that have carried the weight of the NTM earnings reduction.