ANOTHER STRONG EARNINGS SEASON

By Dirk Van Dijk, CFA, Zacks Investment Research

Third quarter earnings season is almost over.  Total net income growth has been far higher than expected, although the median surprise and the ratio of positive surprises to disappointments is slightly below normal.  Thus, I would characterize the season as very good, but we have seen better .  We have 483, or 96.6% of the S&P 500 firms reporting so far.  The year over year growth rate for the S&P 500 (so far) is 15.60%.  That is actually well above the 12.39% growth that those same 483 firms posted in the second quarter.

However, the second quarter was distorted by some big hits to the financial sector, most notably Bank of America (BAC).  This time it reported better than expected earnings and did not have the big “write off” it did in the second quarter.  That resulted in a $12 billion swing in total net income between the second and third quarters.  If we exclude the Financials, the year over year growth rate is higher at 18.73%, but it represents a slowdown from the second quarter, when growth was 20.30%.

The final growth tally for the quarter is likely to be slightly lower than that.  The remaining 17 stocks are expected to actually post  earnings 14.41% lower than last year, down from negative 3.72% growth in the second quarter. At the beginning of earnings second quarter season, growth of 9.7% was expected; 12.2% ex-Financials.  If we combine the already reported results with the expectations, it now looks like the final growth will come in at 14.7%.

If the remaining firms surprise to the upside the way the ones that have already reported do, it is not hard to see the final growth coming in at around 15%.  The bar for the remaining firms does seem to be set pretty low.  While the percentage decline of the remaining firms looks bad, the likely impact on the total results is very low.  The total net income of the 483 is $235.43 billion, while the total expected from the 17 is just $5.16 billion.

Relative to expectations, both earnings and revenues are doing better than expected.  Then again having far more companies report positive surprises than disappointments is entirely normal.  The current ratio of 2.75 (for the 483) is marginally worse than the average experience of the last five years or so (around 3.00). The median surprise is 2.78%, slightly below “normal” (about 3.0%). Still, it is far more positive surprises than disappointments. Top line surprises started off extremely strong, but have faded.  The surprise ratio is now 1.43 for revenues with a 0.62% median surprise.  Not bad, but not terrific either. Top line growth so far has been 11.45%, and 12.17% ex financials, on both counts actually a slight acceleration from the second quarter. The remaining 44 firms are collectively expected see their top lines rise by 3.49%, below the second quarter pace of 7.55%.   All the Financial reports are in.

Expanding net margins have been one of the keys to earnings growth.  That is still the case, with reported net margins of 9.47% so far, up from 9.13% a year ago, and 9.22% in the second quarter (for those 483 firms).  However, the mix of firms that have reported so far is skewed towards higher margin firms, and the BAC effect is very big as far as the increase relative to the second quarter is concerned.  Excluding financials, net margins have come in at 8.56% up from 8.09% a year ago, down slightly from 8.57% in the second quarter.  The remaining 17 firms are expected to post net margins of 5.94%, down from 7.18% a year ago and down 6.17% in the second quarter.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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