What stock pickers need to know about this earnings season, which could see some big misses

Published Wed, Apr 13 20223:26 PM EDTUpdated Wed, Apr 13 20223:54 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

First quarter earnings season is here, and companies are expected to report fewer beats, more misses and more pressure on margins, with producer price inflation running at an all-time high. But overall, the profit picture is still good and companies with pricing power should continue to see solid earnings growth. Earnings for the S & P 500 are expected to grow by 6.1% in the first quarter, down from 8.9% in the fourth quarter, according to I/B/E/S data from Refinitiv. "There will probably be somewhat more misses because the beat rate has been very elevated for almost the entire pandemic," said Julian Emanuel, head of equity, derivative and quantitative strategy at Evercore ISI. "In an environment where earnings are starting to normalize as the pandemic wanes the volatility of earnings is decreasing, and it probably means there will be somewhat more misses." Of the small number of companies that had reported through last Friday, Refinitiv reported a beat rate of 70%, compared to the long term average of 66%, going back to 1994. Over the last four quarters, however, that beat rate was 83%. While still early in the earnings season, Refinitiv notes that the 20 companies that reported by last Friday reported earnings 2.4% above expectations, compared to an average 4.1% beat since 1994 and a rate of 13.3% in the four previous quarters. Emanuel said he is not expecting the earnings season to be a big catalyst for the stock market in either direction. "The whole story is the earnings season is not going to drive the indexes one way or the other," he said. "It's a completely stock picking environment, and earnings season is absolutely going to reinforce that," he said. "It's probably going to skew the way it did to where beats are rewarded but are not proportionately rewarded, relative to misses. Misses will get the stuffing knocked out of them." For now, he expects the market to "chop, chop, chop, chop, chop" and ultimately the market will move higher if Treasury yields continue to calm down. "Our position is the January high is going to get taken out at some point this year," he said. Sam Stovall, chief investment strategist at CFRA, said the impact of rising inflation could start to show up modestly this quarter. The forecast for S & P 500 profit margins this quarter is 12.8%, down from 13.3% in the fourth quarter. "I think with the higher prices and the continued bottlenecks and so forth, and I think the substitution effect that consumers will make as companies aggressively pass forward price increases, that could end up putting pressures on margins," he said. Consumer inflation was running at 8.5% in March, while the producer price index rose a record 11.2%. Analysts do not expect a major contraction in margins, but some could fall slightly and others could stay flat. "We're looking for [margins] this year to be down to 12.8% in Q1 and then hovering around the Q4 level of last year," Stovall said. Emanuel, however, said he expects companies will avoid margin pressure for now since they have the ability to raise prices, but that might not be the case by the summer. Stovall also expects to see more companies miss estimates this quarter. "I think it's a possibility when you think about all the headwinds these companies are likely to endure," he said. Lori Calvasina, chief U.S. equity strategist at RBC, said companies, in their comments, have been focusing on demand, inflation, price increases, the Federal Reserve, and the Ukraine war. She expects those issues to remain a focus this reporting season, "Given the myriad headwinds faced by companies in the 1st quarter and the year ahead, we think 1Q reporting season has the potential to be a mess," she wrote in a note. "But we also see the potential for it to not be as bad as feared, given the likelihood that buy-side expectations are much lower than official sell-side." Calvasina said forward looking expectations are being inflated by the technology and energy sectors. "While some modest margin expansion is baked in to those stats for 2022, in general, sell-side consensus numbers appear to be baking in a flattening of margin trends in the next two years," Calvasina noted. Calvasina said after reviewing the earnings, revenues and operating margins trends by sector, she found that some sectors have done better in terms of upward earnings revisions. "For example, on the 2022 EPS growth rate, expectations for Energy are the highest by a wide margin... While 2022 EPS growth forecasts are also in the double digits for Consumer Discretionary, Industrials, and Materials, most other sectors are well below 10%," she wrote. Calvasina said she believes there could be more risk to 2022 earnings to forecasts for value excluding financial than the growth side of the market. "We also see evidence that some sectors are doing heavier lifting than others in our work on the rate of upward EPS estimate revisions. As of mid April only a few sectors – Energy, REITs, Materials, and Tech – have been seeing mostly upward revisions on both EPS and revenues," she noted. All of those major S & P sectors are represented by ETFs. For instance the energy sector is traded in the Energy Select Sector SPDR Fund , while materials are traded as the Materials Select Sector SPDR Fund, and technology trades as the Technology Select Sector SPDR Fund . Evercore analysts created a list of stocks that they expect could stand to gain this earnings season, and another for those that could take a hit. Among the bottom 25% performers in the Russell 1000, they found the stocks that were in the top 25% of upward earnings revisions. Therefore, those stocks could stand to gain if they beat estimates. They include NVIDIA, Advanced Micro Devices , First Republic Bank, Entegris and Repligen. Conversely, the stocks that performed in the top 25% of the Russell 1000 but had the least positive earnings revisions -in the bottom 25% -could take a hit if they do not do well. Names on that list include Deere, Royal Caribbean , HEICO Corp , Hormel Foods , NortonLifeLock and Sysco.

Traders on the floor of the NYSE, April 4, 2022.

Source: NYSE

First quarter earnings season is here, and companies are expected to report fewer beats, more misses and more pressure on margins, with producer price inflation running at an all-time high.