EPS 'Beats' Lose All Meaning As Downward Revisions, Buybacks Mask Weakness

Good news: companies are beating earnings estimates by the widest margin in four years. For Q1, S&P 500 companies have on average posted bottom line results that have topped estimates by an average of 6.4%, well ahead of the 5-year average of 5.4%. In fact, if the trend holds, this will be the best quarter for FactSet’s earnings surprise percentage since Q1 2011. 

The bad news: this has very little to do with strong corporate earnings and quite a lot to do with analysts cutting estimates. In fact, the bottom-up EPS estimate has fallen by 8.2% in Q1, nearly double the 1-, 5-, and 10-year averages and the largest decline since 2009. 

Via FactSet:

During the first quarter of 2015, analysts lowered earnings estimates for companies in the S&P 500 for the quarter. The Q1 bottom-up EPS estimate (which is an aggregation of the EPS estimates for all the companies in the index) dropped by 8.2% (to $27.05 from $29.48) during the quarter. How significant is an 8.2% decline in the bottom-up EPS estimate during a quarter? How does this decrease compare to recent quarters? 

 

During the past year (4 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 4.3%. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 3.0%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during a quarter has been 4.8%. Thus, the decline in the bottom-up EPS estimate recorded during the first quarter was higher than the 1-year, 5-year, and 10-year averages. 


In fact, this marks the largest percentage decrease in the bottom-up EPS estimate for the S&P 500 for a quarter since Q1 2009 (-26.8%).

This has led directly to the largest decline in the estimated earnings growth rate since the aftermath of the crisis, with EPS growth estimates diving to -4.7% from 4.3%.

And in case the above isn’t clear enough, here’s FactSet again: 

Are companies reporting large upside earnings surprises for Q1 in part because analysts lowered estimates by larger than average margins during the first quarter? The answer is yes.

Consider the following two charts, the first of which shows the glaring disconnect between earnings and stocks while the second shows the extent to which estimates were cut over the course of Q1.

Here's Deutsche Bank, discussing the same main points, namely that buybacks and higher margins (likely helped by layoffs) worked to offset weakness on the top-line:
447 companies or 92% of S&P EPS reported. 59% beat on EPS with a wtd avg beat of 6.2% (6.7% ex Fin), but only 32% beat on sales with a wtd avg miss of -0.9% (-1.5% ex Fin). The wtd avg EPS beat of 6.2% is better than normal, but the 8.2% cut to 1Q EPS before reporting is also the biggest since recession. Btm-up 1Q EPS is now $28.66, 1.9% y/y. The 1Q EPS growth is on -3.4% sales decline helped by 4% y/y margin expansion and 1.4% from share buybacks.
And speaking of share repurchases, April set an all-time record for announced buyback programs, as companies authorized $141 billion in repurchases (up 141% Y/Y). 
As WSJ notes, this puts 2015 on a record pace, meaning investors (and the SNB) can simply frontrun price insensitive corporate management teams for the remainder of the year:
The rise now puts 2015 on pace to reach $1.2 trillion worth of announced buyback programs, shattering the 2007 record of $863 billion in authorized buybacks, Birinyi said Thursday.

 

The research firm attributes the April rise to new programs of $50 billion a piece by Apple Inc. and General Electric Corp. Those programs, for their part, are tied for the largest ever for an individual company. Stock buybacks have been widely cited as giving fuel to the bull market in stocks, now in its sixth year. Corporations have amassed massive cash stockpiles in the years since the financial crisis, plowing much of it into shareholder friendly activities like buybacks and dividends. Cash held by S&P 500 companies stood at a record $1.43 trillion as of the end of the fourth quarter, according to FactSet.

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What all of this means is that between buybacks and downward revisions, earnings "beats" now convey exactly nothing about the health of corporate America. An EPS "beat" is now simply a function of how much stock a company has managed to buy back at the expense of future growth and productivity and the degree to which analysts have slashed estimates over the course of the reporting period.

To sum up, here are four charts from Deutsche that tell you everything you need to know.