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Earnings reports may be backward looking, but there are still many reasons investors should pay close attention to what companies say in them, and why MarketWatch covers them so diligently every quarter.
“It’s a regular reality check, that benchmarks expectations to what’s really going on,” said Brad McMillan, chief investment officer for Commonwealth Financial Network. “And for most companies, things can change quite a bit in three months.”
The Federal Reserve’s interest rate actions have dominated the conversations surrounding the stock market’s performance over the past year. But for investors looking for clues to what the Fed will do this year, look no further than corporate earnings reports, and what company executives say on conference calls with analysts about what they are seeing and expecting in the coming months.
Basically, you can learn a lot more from what people with boots on the ground are experiencing, than from those who are watching from on high.
“It’s the most granular exercise that we have every quarter,” said Quincy Krosby, chief global strategist at LPL Financial. “We’re getting information from companies about how they are selling their products, selling their services and their commodities. We learn what is happening in the world day to day.”
As Krosby explained, investors tend to believe the Fed knows more than Wall Street, but it doesn’t, and they think the Fed’s decisions are very scientific, but they’re not. Fed officials watch the data just like Wall Street professionals, including both macro- and microeconomic inputs.
“ ‘It’s the most granular exercise that we have every quarter. We’re getting information from companies about how they are selling their products, selling their services and their commodities. We learn what is happening in the world day to day.’”
And often the microeconomic inputs, such as changes in what companies in different sectors are experiencing, can lead inputs from broader economic data by months.
That’s exactly why MarketWatch reporters, including the most experienced, continue to cover (without the use of automated reporting tools) the deluge of earnings reports that are released every quarter, with many reports from S&P 500 companies
SPX,
released at or before 6 a.m. Eastern.
And those reporters will spend hours poring over transcripts of post-earnings conference calls, just like their Wall Street counterparts, to identify trends that can provide clues about where the economy is headed.
“It’s not just about what the company reports, but what their customers are saying and what their clients are saying,” LPL’s Krosby said. “That helps us piece together what the macroeconomic outlook is.”
What companies report in terms of earnings per share (EPS) matters, because the higher the EPS, the more investors may be willing to pay for each share, said Commonwealth’s McMillan. And beating or meeting Wall Street projections also matters, because a miss would mean the stock isn’t worth as much as previously expected.
“[Earnings] are a way to see if all of the assumptions or expectations we have about these companies are true or not,” McMillan said. “That’s something we want to check up on every three months.”
With just more than half the S&P 500 companies having released results for the fourth quarter, the results have continued to be “subpar,” as John Butters, senior earnings analyst at FactSet, put it. MarketWatch has noticed several things reported and mentioned in conference calls that portend a further slowing in the economy over the next few months:
Demand for jobs is dropping, despite what government data says
Despite the blowout government employment report for January last week showing the highest number of new hires in six months and the lowest unemployment rate in 54 years, staffing services companies saw demand for jobs drop off in January.
Headhunter ManpowerGroup
MAN,
reported fourth-quarter earnings per share that fell more than forecast as revenue dropped nearly 11%, due to a softening demand environment in both Europe and North America. Based on trends through January, the company expects the “challenging environment” to continue through the first quarter.
Rival staffing company Robert Half International Inc.
RHI,
beat fourth-quarter profit expectations but provided a first-quarter outlook that was below Wall Street projections. The company said demand fell late in the quarter, with revenue from permanent-job placement in December down 1% from a year ago.
The demand decline accelerated to start 2023, with revenue from temporary-job placement down 7% over the first two weeks of January and permanent-placement revenue down from 23% over the first three weeks.
Read more: More than 95,000 tech-sector employees have lost their jobs since the start of 2023.
Sales are rising, but many companies are selling fewer products
Some 55% of S&P 500 companies have reported results through Tuesday morning, and the blended sales growth rate, which includes actual results and estimates of results not yet reported, is up 4.3% from a year ago. But investors should keep in mind that the dollar amount of sales reported is a function of the number of products sold, or volume, and the price of that product.
And many companies that have only reported year-over-year sales increases because they raised prices enough to mask a decline in volume.
For example, Stanley Black & Decker
SWK,
reported fourth-quarter sales that rose 0.1% from a year ago versus Wall Street expectations of a 2.5% decline, but that was because a 7% increase in pricing offset a 10% drop in volume.
Meanwhile, Conagra Brands Inc.
CAG,
the consumer foods company with brands including Birds Eye, Health Choice and Reddi-wip, said sales grew 8.3% from a year ago even as volume fell 8.4%, because pricing and mix increased 17.0% due to “inflation-driven” pricing actions.
That has raised concerns for some companies over what economists call “elasticity,” which is how much demand is affected by higher prices. Higher elasticities means demand is being increasingly hurt by higher prices.
Conagra said the drop in volume was primarily due to the “elasticity impact” from higher prices. But the company wasn’t concerned that elasticity would increase yet.
“Elasticities exist, but they’re, in fact, benign relative to history, and consistent overall, and margins recover,” said Chief Executive Sean Connolly on a post-earnings conference call, according to a FactSet transcript. (Margins refer to gross profit, or sales minus the cost of sales, as a percentage of total sales.)
Procter & Gamble Co.
PG,
which increased prices by 10%, said the shipment volume decline of 6% was a sign that elasticities were becoming less favorable. The company maintained, however, that elasticities remained “benign,” at least for now.
In other words, higher prices have had some effect on demand, but not enough to worry companies much. This will be an important dynamic to monitor in the coming weeks, when retailers, many of which have quarters that go through the end of January, start reporting results.
Earnings results have surprisingly worsened as more companies have reported
The blended estimate for aggregate earnings-per-share calls for a decline of 5.3% from a year ago, which puts it on track to be the first decline since the third quarter of 2020, when COVID-19 was declared a pandemic, according to data provided by Butters at FactSet.
When the fourth quarter ended, the estimated earnings decline was 3.3%. The fact that results have worsened since then is a break from tradition, as over the past 10 years the earnings growth rate has improved by an average of 5.4 percentage points from the end of the quarter to the end of the earnings reporting season, Butters said.
Also read: Why earnings season is shaping up to be a ‘market-moving event.’
Through Feb. 3, 70% of the companies reporting results have beaten Wall Street expectations, but that is less than the five-year average of 77%, Butters said. And in aggregate, companies are reporting EPS that are 0.6% above consensus, which is below the 1.5% beat rate a week ago, and well below the five-year average beat rate of 8.6%.
If the actual beat remains at 0.6%, it would be the lowest percentage since 2008.
As earnings have declined, so have profit margins. The blended net profit margin was 11.3% as of Feb. 3, which is down from 11.9% in the third quarter and below the 12.4% rate seen a year ago, Butters said. The profit margin is on track to be the lowest since the fourth quarter of 2020.
The outlook for the first quarter is not getting any better. Of the companies that have issued guidance for the current quarter, 86% have lowered expectations, which is well above the five-year average of 59%, Butters said.
That has resulted in the bottom-up EPS estimate for the S&P 500 declining by 3.3 percentage points during the month of January, which is more than double the five-year average decline during the first month of a quarter of 1.5 percentage points.
So what does this “subpar” earnings season mean for the outlook for the economy?
“The inevitable conclusion: Corporate cost structures are out of line with demand,” said Nicolas Colas, co-founder of DataTrek Research, in a note to clients. “It is reasonable to assume further layoff announcements are coming.”
Earnings season isn’t all business
Still, it’s not all doom and gloom. Listening to conference calls can occasionally provide some comic relief.
Chief Executive Michael Hsu at Kimberly-Clark Inc.
KMB,
which owns brands including Kleenex, Cottonelle, Huggies and Pull-Ups, talked about a new product coming out in the second half of the year that will “blow your mind” when it’s revealed.
“And it has to do with, not to say this on an earnings calls, but the poop side of things, and so that’s kind of the business we’re in,” Hsu said, according to a FactSet transcript. “And so we’ll do miraculous things with poop.”
And sticking with that theme, powerboat maker Marine Products Corp.
MPX,
which is not a S&P 500 component, reported fourth-quarter profit and sales that rose from a year ago, saying supply chain challenges have “stabilized.”
Chief Executive Ben Palmer said the challenges are still hard to pin down, as surprises can surface week to week, and sometimes day to day.
“Sometimes it’s engines, wiring harnesses and controls, gauges…windshields,” Palmer said. And It’s not constant, which makes it “really, really challenging,” he said.
“I think, toilets, I think toilets is the current issue,” Palmer said.
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