The second-quarter earnings season is shaping up to be the weakest in years, but you wouldn’t know it to look at Wall Street’s giddy response.
The Morningstar US Market Index rose for the week ending July 29 and just had its best month since November 2020.
The explanation: results aren’t as bad as investors had feared given rampant inflation, labor shortages, supply chain issues, shifting consumer spending patterns, and a strong U.S. dollar.
Results Come in Ahead of Expectations
“Companies are clearing a low bar,” says Andy Kapyrin, partner and co-chief investment officer at RegentAtlantic, a Morristown, N.J.-based registered investment advisor with $6 billion under management. “Expectations were low.”
According to John Butters, senior earnings analyst at FactSet, a Norwalk, Connecticut-based data provider:
- Of the 56% of companies in the S&P 500 that have reported earnings through the morning of July 29, 73% delivered earnings per share above estimates.
- However, those results are below the five-year average of 77%.
- The magnitude of the earnings beats, by 3.1% on average, is paltry compared with the five-year average of 8.8%.
The quarter also highlighted sharp performance differences among companies within industries, putting more scrutiny on management execution. Wall Street is demanding more visibility from companies and forward guidance is more critical, especially since many stopped providing it during the past two years because of the unpredictable conditions. For those companies missing expectations and lowering guidance, the outcome has been punishing.
The Outlook Had Better Be Good
Case in point: Investors sold off shares of Meta META, the parent company of Facebook, after its results missed expectations and it reported its first-ever quarterly drop in revenue. Moreover, it said it expected revenue to fall in the third quarter. The social media company blamed the results on a strong dollar, softening digital advertising sales, and competitive pressures. The stock has fallen more than 8% since it released results after the close on July 27.
Still, other technology titans such as Microsoft MSFT, Alphabet GOOG, and Apple AAPL saw their stocks soar based on more positive outlooks.
The world’s largest retailer Walmart WMT issued disappointing results and lowered guidance while rival Amazon AMZN beat estimates and gave upbeat guidance.
All About the Company and Not the Industry
“It’s about how your business is being managed and not about what business you are in,” says Kapyrin. “It’s about how you are executing, how nimble you are and how good you are at controlling your costs, and then can you pass those costs on to the consumer.”
Compared to recent quarterly earnings growth the second quarter has been weak, says Dec Mullarkey, managing director of investment strategy and asset allocation at Boston-based SLC Management, a unit of Sun Life Financial SLF, with $268 billion under management.
“Part of that is a high year over year comparison, as Q2 2021 was very strong. Another drag on earnings are macro headwinds that range from disruptions in Europe to the effects a strong dollar is having on muting overseas revenue growth. The energy sector has been the standout as prices surged on supply interruptions. Industrials, materials, and real estate have also performed well.”
Indeed, oil giants ExxonMobil XOM and Chevron CHV posted record profits in the second quarter, fueled by high oil and gas prices and tighter cost controls. Energy continues to be the top-performing sector this year with a gain of about 35%.
While the number of companies reporting higher-than-expected revenues stands at 66%, down from the five-year average of 69%, according to Butters at FactSet, the margin by which they are beating, 2.5%, is wider than the five-year average of 1.8%. All 11 sectors are reporting year-over-year growth in revenues, led by Energy, Materials, and Real Estate, he adds.
“Most companies are still seeing revenues growing at a decent clip,” says Kapyrin, which he sees as a sign that they have been able to pass through higher prices to their customers.
Companies More Circumspect
That may be, but SLC’s Mullarkey notes that what's most surprising from this earnings season is “how circumspect, or negative, companies are on earnings calls. Many seem particularly worried about recession risk.”
One of those companies was McDonald’s MCD, which reported double-digit gains in comparable global sales in the quarter driven by price increases. Chief executive Chris Kempczinski noted that “in the last six months, the macro uncertainty has only increased.” He went on to cite the war in Ukraine, the highest inflation in 40 years, rising interest rates, weak consumer sentiment around the world and the possibility of a global recession.
“We’re mindful of these risks, and we’re planning for a wider range of scenarios,” Kempczinski.