July 18, 2020
Earnings are starting to roll in pretty quickly for the second quarter, and a quick review should highlight some of the damage being done by the COVID crisis. When you bring up headlines, however, things look pretty good. A more nuanced analytical review highlights a few issues which investors should be aware of.
As usual, the focus is on the S&P 500. The three key reasons for this are: (1) the data is fairly easy to find, (2) The data represents a very, very broad swath of the economy; (3) the data is comparable over long periods. The caveat here is that the data ignores smaller companies that are being particularly hard hit in the COVID crisis, and it misses some interesting, yet meaningful information that can be found with smaller or less well known businesses.
The basis of the analysis today is an earnings update from FactSet. You can find that update here. Like others, the company offers a snapshot; an overview of earnings for the market to highlight how things are going. This review has a nominal (think boring) name which doesn’t suggest any biases. In fact there is a significant bias that makes things look much better than they are. Here are two prominent quotes from the first paragraph of the release:
the percentage of companies reporting actual EPS above estimates (73%) is above the five-year average”
the percentage of companies (78%) reporting actual sales above estimates is above the five-year average”
Sounds awesome right. To be clear, there is nothing wrong with the information in the report. The bit that requires the attention of investors is to read the whole report. Really understand what has actually happened.
When reading the entire report, FactSet puts in a number of easy to read graphs that show the Earnings and Earnings Growth as well as Revenue and Revenue Growth for the companies that have reported and even break it out by major sector.
Those graphs tell a far less exciting story about earnings. The second chart of each set, the ‘Earnings Growth’ and ‘Revenue Growth’ show that of the companies reporting Earnings Growth is down 44% and Revenue Growth is down 10.5% for the companies that have reported so far. Those are substantial numbers.
Another bit of data that is clear is that no company that has reported so far (zero, zip, nada) has shown any growth in earnings and only one sector, health care had any revenue growth, and it was less than 1%.
Again with the caveats, the opening paragraph tells us that 9% of the companies in the S&P 500 have reported (less than 50), and so there is a lot of data to add. FactSet itself goes on to discuss the negative aspects of these numbers (it’s highlighted in the second paragraph, but many don’t get that far), and even goes one step further. Here is another quote:
“[This] will also mark the fifth time in the past six quarters in which the index has reported a year-over-year decline in earnings.”
In other words, company earnings have not been improving for at least 15 of the last 18 months. The COVID crisis has only been ongoing for six months. With all of the firepower offered up over the past four years (or ten if you want to include the support from the three rounds of QE during the Great Recession), the market was stalling out before the COVID crash.
There are only so many ways to look at the data and conclude that the days of 8-10% growth are likely over. Of course it is difficult to imagine, when the market is enriching you, that the market is too expensive.
The liquidity enriching investors is tax dollars that are going to a very narrow band of companies, driving prices higher. All of the debt and financial support, liquidity and financial engineering, will only work for so long (versions of these same techniques have been used by companies such as Nortel, Enron, Bear Stearns, Lehman Brothers and more recently Chesapeake Energy) and are likely to make the downside even more harsh and last longer.
Earnings will continue to pour in over the next three weeks, and despite some probable big wins by technology companies, perhaps some consumer brands, there is a lot of bad news left to come and the COVID crisis is still in the early innings.