Juggling Expectations

9/25/2017


My three-year old daughter responds best when my wife and I telegraph our intentions and then stick to the plan. Managing the expectations of a toddler is not unlike how companies issue guidance for investors.

Like companies giving their forecasts at the beginning of a quarter, we introduce our outlook for the night after dinner: Movie, brush teeth, books, bed. And like companies issuing midquarter updates, we'll reiterate our plan as the evening progresses by peppering her with rhetorical questions. "What are we doing next?"

Sometimes we let the movie run an extra scene or read a third book, essentially a profit surprise. In these instances, she rewards us with an excited laugh. But we could be setting ourselves up for a tantrum tomorrow. She may hear two books but expect three. And once she expects three books, she'll only be truly happy if we read a fourth.

Investors have certainly grown accustomed to getting that third book. Nearly three-fourths of S&P 500 companies topped consensus profit estimates last quarter, consistent with long-term norms. The index's per-share profits grew 12.4% in the second quarter, above the 8.0% target when the quarter ended June 30. That 4.4% surprise is roughly in line with the index's average of 4.3% since 2009. Recent growth reflects the energy sector's rebound and strong operating momentum from technology stocks.

S&P 500 PROFIT TRENDS

--------------------- Per-Share-Profit Growth Rates ---------------------
--------------------------- 2017 ---------------------------
-------- Estimated --------
S&P 500 Sector
First
Quarter
(%)
Second
Quarter
(%)
Third
Quarter
(%)
Fourth
Quarter
(%)
Average
Since 2010
(%)
Consumer discretionary
6
4
0
11
19
Consumer staples
4
5
3
9
5
Energy
NA
534
135
90
35
Financials
20
12
4
16
66
Health care
7
9
4
7
9
Industrials
4
7
6
13
11
Materials
19
6
1
23
18
Real estate
3
5
3
0
5
Technology
20
18
10
12
15
Telecom
(5)
5
(1)
1
5
Utilities
3
6
(2)
3
2
S&P 500 Index
15
12
6
12
11
NA because earnings for prior year's quarter were negative.  Note: Real Estate sector data goes back only to the second quarter of 2015.

During earnings season, stocks react less to the actual corporate results than to how those results compare to expectations. To keep expectations in check, companies try to steer analysts toward trimming their forecasts. Analyst estimates are notoriously optimistic and tend to contract as the future comes into closer focus. Not since the first quarter of 2011 has the S&P 500's consensus profit estimate risen over the course of a quarter.

This pattern is playing out again as the third quarter comes to a close.  Analysts currently expect the S&P 500 to produce 6.0% higher profits, versus the 8.6% growth projected on July 1. That 2.6% intra-quarter decline compares favorably to the 3.3% average decline since 2009.

Managing expectations can save parents — and companies — from headaches. But investors, spoiled from years of profit surprises, may have come to expect that companies will not only surpass estimates but top estimates by more than normal — and perhaps raise their guidance, for good measure. If current estimates hold for the third quarter, and the S&P 500 goes on to post a surprise by 5.0% or more, we could be getting a fourth book before bed.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com