July 1, 2016

Analysts are Pessimistic on Q2 Earnings, Companies Themselves are Less So

by Greg Harrison

The first quarter earnings season is over, and the results, while still very weak, are not as bad as feared. With all 500 companies in the S&P 500 index having reported, aggregate earnings fell by 5.0%. While this is better than the 7.1% fall in profits that analysts were projecting at the beginning of earnings season, it is still the weakest quarter of earnings since Q3 2009.

Looking ahead, analysts see earnings continuing to fall for the second quarter, although not as much as in Q1. Currently, the consensus for Q2 calls for a 3.9% drop in earnings. As seen in the exhibit below, this is more pessimistic than the analyst outlook at the beginning of the quarter, when analysts were projecting a 2.2% earnings decline.

Exhibit 1.  S&P 500: Q2 2016 Earnings Growth Estimate Revisions


Source: Thomson Reuters I/B/E/S

At the same time that analyst estimates have become more pessimistic, earnings projections given by the companies themselves have become less pessimistic than usual. Of the 131 preannouncements issued by S&P 500 companies, there have been 2.3 instances of negative guidance for each positive. While optimistic projections are outweighed by pessimistic ones, this ratio is less negative than any quarter since Q1 2012, as seen in the exhibit below. This shows that estimates have fallen to the point where more companies are more confident in their ability to post stronger earnings than expected by analysts.

Exhibit 2.  S&P 500: Negative to Positive Guidance Ratio Trend


Source: Thomson Reuters I/B/E/S

The Information Technology sector has had the sharpest downward revisions, with analysts cutting the Q2 growth estimate for the sector by 7.4 percentage points to -6.0%. However, company issued guidance in the sector suggests that the analyst estimate revisions may have been too pessimistic. Within Tech, there have been 22 negative preannouncements and 14 positive, for an N/P ratio of 1.6, below the overall N/P ratio for the index. Additionally, revenue guidance for Technology companies is strong, with an N/P ratio of 1.3.

There have been some notable technology companies giving positive guidance, despite analyst pessimism and an uncertain global economic outlook. Cisco Systems Inc (CSCO.O) gave Q2 EPS guidance of $0.60, when analysts were only expecting $0.58. Cisco CEO Chuck Robbins gave his outlook at the time, saying, “I think in the near term we see, obviously a mix of a pretty cautious environment still, because we do see customers spending where they need to spend. But don’t misunderstand; there is still a fair amount of caution in the market.”

Applied Materials Inc (AMAT.O) had the most dramatic difference between analyst estimates and company guidance among technology companies that have given positive preannouncements. At the time of guidance, the analyst consensus estimate was $0.36; the company provided its own projection of $0.48. Applied Materials expects to benefit from a shift in memory chip technology, requiring chip companies to invest in new equipment. CEO Gary Dickerson explained the drivers of the optimistic guidance, saying, “This quarter, our revenues in China are at an all-time high. In memory, we expect overall spending to be more or less flat year-on-year, however, there are important changes in the mix that play well for Applied. Investment is shifting from DRAM to NAND, and we see DRAM down at least 25%, following very high investment levels in 2015. In contrast, we see NAND strengthening as the year progresses.”



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