earnings season

Upcoming Earnings Season Will Help Justify Market Valuations

Heading into the upcoming earnings season, it’s no secret that the Stock Market continues to do well.  With 9 years of a bull market under its belt, what are the catalysts that could drive the market higher? Besides the dearth of other investment choices, earnings continues to be the foundation upon which this market builds. This makes the fourth quarter, or, upcoming earnings season a very important marker. So starting in a couple of weeks, everyone will be reading the earnings announcements with anticipation.

Let’s take a look at some of the top line numbers. My next blog post will dive into Sector performance, but this one highlights the market in general. I have used the data in Factset’s Earnings Insights as a data source for this post: you can access it here [PDF].

When you look at any upcoming earnings season, you want to see three things:

1. Strong  Growth Rate—this is measured on a year over year basis. So in Q4, we will be comparing 2017 Q4 reports with the ones done in Q4, 2016.

2. Positive Earnings Surprise—When a company outperforms the Wall Street analyst estimates, often that means good things for the stocks.

3. Strong Leadup  to the Upcoming Earnings Season—Typically companies try to “Pad the Mat,” which means soften the estimates so that they can report an earnings surprise. Companies hate to disappoint with a rough Earnings report – so if they get a lower analyst estimate, they can improve the optics of the earnings report.

When you are standing at the start of earnings season, we have information that points to the direction of Earnings, and we can see whether companies have been lowering guidance or whether analysts have been lowering estimates. So really we have very good indications on points 1 and 3 above. These datapoints can give a very strong hint at how the Q4 Earnings is going to look.

Let’s start with Earnings Growth. Factset is reporting that analysts expect 10.9% earnings growth for Q4. That is a very respectable number, and helps to justify the valuations currently in the market. People should be willing to pay more for companies if  their earnings are growing rapidly.

Even better, the leadup to this upcoming earnings season has been very muted. Only 72 companies within the S&P 500 have lowered their guidance for this quarter’s earnings. That is a smaller than normal number and bodes well for the upcoming earnings.

Analysts have noticed this, and have kept estimates virtually flat for this quarter since September. Usually 1-2 months before the quarterly report, you will see analysts dropping estimates by several percentage points. So they clearly feel this is going to be a strong quarter.

All of this adds up to a strong outlook for the Q4 Earnings. It should be a catalyst for some future price performance in the market except in the rare case where a company disappoints.