Trader Talk

High expectations will put pressure on companies this earnings season

Key Points
  • Estimates for the S&P have dropped by only 0.3 percent for the fourth quarter, the smallest decline since the last quarter of 2010.
  • So far, 75 S&P 500 companies have issued negative EPS guidance and 35 S&P 500 companies have issued positive guidance, according to FactSet.
  • The 19 S&P 500 companies that already have reported earnings have put up strong results.
Dr. Mehmet Oz takes blood pressure of trader Mark Otto at New York Stock Exchange on February 7, 2011 in New York City.
Charles Eshelman | FilmMagic | Getty Images

There is much more at stake in this earnings season than usual.

The great marginal mover of stock prices last year— the hope of tax cuts — has now become a reality. Prices are at historic highs across the board, in most sectors, in all market caps, and not just in the U.S. It is highly likely investors will demand unusually strong earnings beats and guidance to sustain prices.

The investing community is very optimistic about earnings. Analysts typically lower earnings estimates as the quarter ends, but not last quarter. Estimates for the dropped by only 0.3 percent for the entire quarter, the smallest decline since the fourth quarter of 2010.

In most quarters, the final S&P earnings are about 3 percentage points above analyst estimates, but with analysts so optimistic, we may not see that kind of beat. Investors are expecting the opposite: bigger beats. They will likely be more willing than usual to punish companies with in-line or disappointing numbers.

"This is going to be a big quarter for guidance," Christine Short from Estimize told me. "Tax cuts were not baked into guidance last year, so investors are expecting much more clarity on what could happen, including on repatriation of foreign earnings."

You can bet investors want to see more companies raising guidance to justify the high prices. In most quarters, of those that offer guidance, about 35 percent will guide up and 65 percent will guide down. For the fourth quarter of 2017, 75 S&P 500 companies have issued negative EPS guidance and 35 S&P 500 companies have issued positive guidance, according to FactSet.

Investors are expecting a higher percentage of companies to raise guidance.

Investors also are expecting more aggressive buyback announcements in the wake of the tax cuts. And expectations for capital investments are equally high, also thanks to tax cuts.

Can CEOs really deliver on these high expectations? To me, this sounds like a pretty tall order. But there's some reason for optimism.

"A lot of good news has been priced in already, but I really like what I'm hearing from companies so far," Nick Raich from The Earnings Scout told me. "Revenue growth has been strong, and I am hearing more noises about capital spending."

He's encouraged because the 19 companies in the S&P 500 that have reported earnings so far have put up strong results. The 19, which includes Oracle, Carnival, Darden, Walgreens, FedEx, CarMax, Constellation Brands, and others, have reported average earnings growth of 18 percent, and sales gains of 11 percent.

That is 50 percent above expectations for the S&P as a whole for the quarter: 11 percent for earnings, 7 percent for revenue.

The numbers have been so strong analysts are raising earnings estimates. "That's great...we haven't seen analysts raise estimates in an earnings season in six years."

For Raich, capital spending is the key to sustained stock price growth. "When one company starts to spend, that is helpful to other companies. Buybacks are only helpful to the company buying the stock. Capital spending is part of the animal spirits we keep hearing about."

"If they increase spending, the rally could be extended for another 12 to 18 months."