What are our biggest takeaways from companies' recent earnings reports? Has the factor rotation from growth to value come to an end? We tackle this and more on The Pulse.
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00:04 - 00:39
Everybody, welcome to The Pulse, where we cover trends in the economy, markets and asset allocation for long term investors. I'm Matt Palazzolo, Senior Investment Strategist at Bernstein and head of our investment insights team. Today we're welcoming back Bernstein Research US quantitative senior analyst Ann Larson. Because with the U.S. economy clearly slowing, two key areas of focus for us have been corporate earnings and sector trends. And data and analysis give her valuable perspective on the overall market as well as what we've been seeing as companies have reported earnings over the past couple of months. So, Ann, welcome back to The Pulse.
00:39 - 00:41
Thank you so much for having me back on.
00:41 - 00:56
So just remind our listeners why earnings season, which we just completed, is so important just in general, but then and then in particular, right now, over the last few months, as the economy has slowed and there's been so much volatility in the markets.
00:56 - 01:33
Yeah. So, this is really important not only because businesses are going to have told us how they were performing in Q2, but also, we get a look at their outlooks. Right. So, from the analysts and from the companies themselves, how they see the second half of the year and 2023 giving guidance and change in their guidance is an area of scrutiny right now, more so than usual, because everyone's looking for that growth, slowdown, or recession. How bad is it going to be? And looking at these companies for evidence of where we're going.
01:33 - 02:00
Right. The concern has been of a recession that hasn't yet shown up in the earnings numbers, either the reported numbers or in the forecast by Wall Street. And so that's why as we read and listen to CEO expectations for the future, Wall Street is certainly focused pretty intently on that. So, we've just gotten through the second quarter. So, this is for most companies through June, their second quarter earnings.
02:00 - 02:06
And so, from your perspective and what were some of the key takeaways as you listen to conference calls and read, they’re their 10-Q?
02:07 - 02:55
Yes. As they reported, about 82% of companies met or beat estimates, analysts’ estimates. And that is actually I mean, 82% sounds high, but it's actually below the beat ratios that we've been seeing over the last two years. So, when we were in the middle of the pandemic and even in the recovery, the analysts were on the street, were reluctant to reduce forecasts enough. Right. So, they didn't want to cut estimates and go too far. And so, they sort of left a low bar there for companies to beat. So, the beat ratios of the last two years were very high in the high 80%, even low 90%. And now we're at 82%, which is still good relative to the long-term history from 2008.
02:55 - 03:16
You know, it's above that, but it's coming down. It's decelerating since the last two years. And the revenue beat ratio is 69%. So, 69% of companies were able to beat analyst forecasts on the revenue line. And that is also below what we've seen over the last two years, but above the longer-term average since 2008.
03:16 - 04:01
You know, overall, for growth, you know, we've seen that earnings were up 8% on 9.7% higher revenues. And that's impressive. You know, last year, if we're doing quarter over quarter, the second quarter of 2021 was extremely high earnings growth rates of 63%. And that's because it was lapping the quarter of, you know, in the middle of the pandemic, Q2 2020. So, after coming off a quarter of 60%, 63% in Q2 2021 and then 8% in Q2 of 2022, that's impressive. So, we haven't seen a recession yet. But, you know, analysts’ forecasts are coming down.
04:02 - 04:52
And you've thrown in a lot of good numbers at us. I want to just encapsulate or go over a couple of these 82% of companies that reported for the second quarter beat Wall Street expectations for earnings, 69% beat on revenues. The overall numbers for growth year over year for the companies that reported revenues were up 9.7%. Let's just round up and call it a ten, 10% revenue growth or sales growth and earnings were up about 8%. To me, that seems like the most important takeaway. And I'd love your your thoughts on this with earnings up eight, but sales up ten. To me, it's been a long time since I've been in an Excel spreadsheet, but that sounds like margin compression. What is what are we looking at in terms of cost pressures for these companies that would lead to margin compression?
04:53 - 05:22
Yeah. So, there was a lot of talk as companies were reporting of cost pressures, obviously, you know, inflation for they’re their supply chain problems. And so, we are seeing some margin compression. And this quarter, it's it's forecast to be about 12.3%, which is about 1% lower than it was last year. So probably heading for four more of margin compression, although analysts have been slow to change their forecast, but they are heading down.
05:22 - 05:43
Yeah. The other big you didn't mention this, but I think I have to assume that the other big influence on earnings this quarter was the strong dollar. The dollar is up meaningfully relative to the basket of other major currencies over the past 12 months. What influence, if at all, has that had on earnings, particularly those that have non-U.S. sales?
05:43 - 06:36
Yeah, so we've seen that there has been a difference in the earnings growth rates and the earnings revisions, meaning analysts, you know, how are they changing their forecasts for forward quarters in addition to what they actually reported for the second quarter? We found that there was a difference. So companies that had more U.S. geographic sales exposure, which means more of their revenues are coming from the U.S., had better earnings growth and also better earnings revisions from the analysts. So forecasts are going up as well, or at least not down as much, I should say, versus companies that have more international exposure. So the companies that are more global, international and sourcing more of their revenues from outside the US didn't grow as much and they're analyst there. Their earnings forecasts are not there. They're more negative than the companies that have more domestic exposure.
06:36 - 07:07
You always do a good job of looking at not only what the earnings reports are and what that means for the growth that we just covered. But but also the performance of the stocks after they report their earnings, because at the end of the day, that's what really matters is the expectations. And then if they beat on the top line or miss on the bottom line or whatever permutation you might come up with, what does that mean for how the stock trades that day over the next couple of days? What are the key takeaways after the second quarter for how the stocks performed once they report it?
07:07 - 07:36
Yeah. So this quarter we had we saw a negative skew to the reactions, meaning that, you know, when stocks beat on both earnings and revenues, they were up not a lot. So less than 1% and that is not a usual reaction. Usually see a more positive reaction when stocks beat on both earnings and revenues. But part of the reason for that is that the investors were looking more towards the second half of the year than reacting to the current quarter.
07:36 - 08:28
And then we saw on the negative side, however, if they miss, then that made more of a difference as far as the market reaction. So companies who missed on both the revenue line and the earnings line sold off by more than 4%. So that's more of a reaction than we normally get. So reacting more to negative news than positive news, and that's looking ahead to what the companies said, what guidance they gave for the rest of the year, what kinds they gave to 2023, more so than, you know, reacting to what happened this quarter, if companies reported on the top line or the bottom line. So they they beat on the top line, but not the bottom line or vice versa. So they didn't beat on both or miss on both. The companies were down an average of 2 to 3%. So there was a definite negative skew to the investor reactions, their earnings this quarter.
08:28 - 08:53
Yeah, I'm always curious about whether or not, you know, what percentage of companies, just rough numbers or directionally provide future guidance because as you've mentioned, you know, what happened in the past is the past. But what really what matters for investors today is what the outlook for the business is going forward. Do most companies today provide guidance to the street about future quarters, either the balance of the year or into the next 12 months?
08:53 - 09:46
Companies giving guidance, you know, changes over time. We've seen during the pandemic that the number of companies giving guidance was dropping dramatically because companies didn't know what their earnings were going to be. And so a lot of them stopped giving guidance. But now we're seeing last quarter in this quarter that the share of companies giving guidance is normalizing to around 65%, which is what we saw pre-pandemic from around 50%, which is what we saw during the pandemic. So it's certainly not all companies giving guidance, but around two thirds of companies will give guidance, which is good for the companies themselves, because what they're doing when they're giving guidance is they're trying to get the analysts down to a number they can beat. So if they don't give guidance, the analysts tend to be a little too optimistic, and then they usually have more frequent misses when they don't sort of give the the analysts anything to work with.
09:46 - 10:00
Little game they play. Yeah. So were there any takeaways in terms of sectors? We often get asked about whether or not the sector did better than this sector or which ones are performing better. Any takeaways there?
10:00 - 10:49
Yes. So, all sectors beat back. Haitians this quarter and the amount that they beat by is normalizing as well. So, during the pandemic, companies were beating, as we said, you know, the analysts were sort of reluctant to to change their earnings. So the the companies were beating by larger margins of about 10 to 15%. They were beating consensus. The companies were being consensus by ten or 15%. That's very high relative to history. The historical percentage that companies beat consensus by is around 3 to 5%. And so we saw that that companies overall this quarter were beating by about 5%. So getting more in line with historical averages and coming down from the percentage that we had seen during the pandemic.
10:50 - 11:15
And that varied a lot by sector, though. So industrials were beating by about 10%. So their their earnings were coming above consensus by 10%. And we saw that, for example, real estate and utilities, those were not really sectors where you could pick winners and losers because there was only a half percent or more or less of potential outperformance.
11:15 - 11:27
And energy was a big contributor, I have to assume, with the run up in oil prices. Right. Is that was that a standout this quarter in terms of either top bottom line growth and or beats relative to consensus?
11:27 - 12:09
Yes. So energy was dominating this quarter. The percentage of earnings that earnings growth that we saw was over 100%. So most of the of the positive earnings that we saw and actually positive earnings revisions were for the energy sector. Financials was the biggest headwind and we expect this pattern to continue for Q3. So in Q3, current forecast for energy is 125% growth on 46% sales growth. So still by far, I mean, you know, they're coming from very depressed earnings. So, you know, they've had a few quarters of dominant earnings growth and that's expected to continue next quarter.
12:09 - 12:38
And I want to ask you in a little bit about the back half of 2022 and 2023 before we get there, you and I, last time we got together, we chatted about value and growth and certain sectors. I think tech was in your team's focus. But is there anything that your team has done work on that that would highlight either value or growth as potentially having a better opportunity going forward or at this point in time is there less conviction one way or the other?
12:38 - 13:15
Yes. So thank you for remembering that we did talk about value overall within tech and that that actually worked out, you know, value dominated the first half of this year, both in technology and in the broader market. So when we did our outlook for the second half, we recommended a rotation, you know, a change in the barbell that we recommend between value and growth to a balanced barbell. So instead of a value to tilted barbell, we're recommending a balance between value and growth because, you know, particularly when we're talking about the tech sector, valuations have come down quite a bit.
13:15 - 13:44
So the most expensive stocks, when we looked at technology at the beginning of the year, they were at 17 times sales in November and now they're at five times. So they've come down. Our valuation concerns have been mitigated to some extent, and so we favor selectively adding to high quality, high growth names within the sector, whereas before we were looking at value or a combination, what we call quark. So quality at a reasonable price. So a combination of value and quality.
13:45 - 14:37
So the reason that we're recommending a balance instead of just going full on growth is that we still have some macro headwinds, right? So we still have, you know, interest rates potentially increasing, which, you know, is not going to be favorable to the super long duration stocks like the unprofitable stocks of technology. You know, we don't want to go full on growth exposure, but we do want to have a balance because there is, you know, with higher inflation, higher rates, the value side has some positive exposure there. But with the high quality, high growth names, especially high quality, that's good. And if we get into a recession, right. So that's going to be more defensive exposure. And like we said, you know, the valuations have now come way down given what happened in the first half. So we think that that's really, you know, good positioning in the tech sector and good positioning overall.
14:38 - 15:18
I'm glad you mentioned that our team has done some similar work here as well. And, you know, given the backdrop of a high degree of uncertainty, economic and otherwise valuations where they are and a whole host of other influences, we've identified a couple of interesting areas for investors that are looking to put capital to work in an opportunistic way, growth being one of them. But as you mentioned, growth is not monolithic high. Quality growth is really an area that we have focused on given this uncertainty that they can ride out any challenges but still deliver above average earnings growth over the foreseeable future. So it's good to hear that we've got some consistency there between our team and yours.
15:18 - 15:49
Just a couple more questions and before we let you go, as we look into the back half of 2022 and 2023 in total. Any thoughts on what earnings and sales growth might be? You know, directionally or more specific? Because as we mentioned at the top of the show, the economy is clearly slowing in the United States and everybody is waiting for earnings to slow in lockstep with the slowing economy. But it hasn't happened yet. Will it happen over the next 18 months or so?
15:50 - 16:48
So what we see when we look out to the second half of this year and 2023 for earnings growth is low to mid single digits. Earnings growth right now with the consensus forecast and we expect that to come down. They usually the forecasts do usually come down as you approach earnings season. So we don't have a forecast for earnings recession yet, but we do expect that these forecasts that are between 5% and 13% or probably 13% is out in second quarter of 2023. We expect that those will be coming down as we get closer to two next year. So when we look at it by sector, we can see that a real shift in the sector contribution to earnings. So even though it's still positive through next year, we see that energy is from Q4 on is no longer the dominant sector.
16:48 - 17:39
Right. So we have a sort of industrials and energy leadership right now. And going forward the next four quarters, we see that that shifts to defensive sectors, right? So we're shifting from industrials and energy to utilities, staples and real estate leading earnings growth over the next four quarters right now versus consensus, which is a big change from what we had prior, which was technology for a long time. And then what we've had in more recent quarters, which has been the cyclicals and value sectors. And now in the next three or four quarters, we have the defensive sectors picking up and that sort of aligns with what the exposures that we see when we look at what are the favorable exposures in a recession or a growth slowdown.
17:39 - 18:05
So when you think about that, the factors that we as quants would have seen historically are the most favorable in a growth slowdown or recession. Are things like low volatility, quality, still value, but more of the defensive value. So free cash flow yield and dividend yield rather than the price to book and price sells. And so, you know, I guess that aligns with the sector paradigm saying.
18:05 - 18:16
Well, I guess only time will tell. Ann, I want to thank you once again for joining us on The Pulse. It's always good to have you on the show and for you to share some of the research that you and your team have done. So thanks a lot for joining us again today.
18:16 - 18:18
Thanks so much for having me on again. It's a pleasure.
18:19 - 18:50
And to all of our listeners, thank you for joining us as well. Hopefully this pulled back the curtain a little bit on how in some ways this earnings season was filled with some good news. But at the same time, there have been some headwinds to earnings growth that you may have expected. So if you enjoyed this podcast, please subscribe and rate us on Apple Podcasts or Google Play or Spotify or wherever you listen to podcasts and emails with your thoughts or questions or any feedback that you might have to insights at Bernstein dot com. And be sure to find us on Instagram and Twitter at Bernstein P.W.. Until next time. Thanks a lot and be well.