Earnings growth of 6-7% doesn’t sound very exciting, but given the challenges corporate America has faced, we consider the nearly-complete second quarter earnings season a resounding success. The numerous challenges last quarter included a slowing economy, intensifying inflation pressures, ongoing global supply chain disruptions, and a surging U.S. dollar. Still, corporate America delivered the type of upside investors have grown accustomed to in much easier economic environments.
We anticipated more modest upside to estimates in the second quarter and that’s what we got. Some of the key numbers include:
- Estimates for S&P 500 earnings per share (EPS) growth coming into reporting season were around 4.1%. That number looks like it will end up at around 6.2%, according to FactSet estimates [Figure 1].
- Revenue grew a very solid 14% year-over-year, well above the roughly 10% expected when earnings season began.
- A solid 76% and 71% of S&P 500 companies beat their earnings and revenue targets, similar to five-year averages.
- Energy delivered the fastest earnings growth among sectors, nearly quadrupling profits from the year-ago quarter. The sector also posted the second biggest upside surprise among all sectors at 9 percentage points, trailing only utilities.
Focus on profit margins
In our last Equity Strategy Insights publication, we highlighted profit margins as one of the key factors to watch during reporting season. We had posited that published estimates for profit margins were too high but that they were unlikely to come down significantly. Estimated profit margins for the second half of 2022 did indeed come down as companies reported, but not dramatically so.
Strong revenue growth in the mid-teens is one big reason why margins are holding up in this inflationary environment. That additional revenue, and the pricing power that helps produce it, provides companies with some margin cushion to help them reach their earnings targets.
Analysts’ estimates no longer reflect margin expansion in coming years. We know analysts’ estimates tend to be overly optimistic, but we still view expectations of stable margins as a positive sign for future profitability. That said, earnings targets will be very tough to reach in 2023 if high inflation lingers. The pace of improvement may be stubbornly slow despite some progress toward normalizing supply chains and loosening labor markets.
Estimates for this year look reasonable, 2023 have to come down
Coming into earnings season, the overwhelming view from Wall Street strategists was that earnings estimates had to come down substantially. The thought process for many was that earnings drop in a recession, so while 2022 profits may be near consensus estimates (our expectation), 2023 may see a profit decline. That would make our $235 estimate for S&P 500 EPS in 2023 overly optimistic and potentially put something like $200 in play (not our expectation).
Figure 2 shows how resilient 2022 earnings estimates have been. The consensus estimate for S&P 500 EPS for 2022 at $226 is still slightly above our $225 forecast. And despite coming down about $8 from its prior high, the consensus estimate for S&P 500 EPS in 2023 is still near $244, well above our $235 estimate despite mostly cautious guidance from corporate America and pretty dour sentiment from business leaders.