The results from the fourth quarter are in.
In the last three months of 2018, the S&P 500 index dropped 14.2 percent and investors were seriously concerned about an end to the decade-long bull market in U.S. stocks. At the time, the primary cause of concern was fourth-quarter earnings season. Experts feared the impact of the ongoing trade war with China and a slowing U.S. economy as companies get diminishing returns from the 2018 tax reform. Now that earnings season is nearly complete, here are seven things investors should know about the health of the stock market, according to Factset.
There were plenty of red flags.
About 70 percent of S&P 500 companies have reported earnings beats in the fourth quarter, slightly below the long-term average of 71 percent. In addition, the average earnings beat this quarter has been only 3.5 percent above consensus estimates, well below the 4.8 percent average earnings beat over the past five years. To date, the average year-over-year earnings per share growth for the fourth quarter is 13.1 percent, the weakest growth for the S&P 500 in a year. Fortunately, 62 percent of companies have reported revenue beats, slightly above the five-year average of 60 percent.
Investors are shrugging off the bad numbers.
Fourth-quarter numbers have been mixed at best, but they may not be as bad as some had feared. After that brutal fourth-quarter performance, the S&P 500 has bounced back by 11 percent in early 2019. This earnings season resiliency can be seen in individual stocks as well. Factset reports that companies reporting earnings beats have witnessed larger share price gains than is historically typical this earnings season. In addition, companies reporting earnings misses haven’t been punished as harshly. The average immediate share price reaction to earnings misses this quarter has been only a 0.4 percent decline.
Some companies had a huge quarter.
Each quarter has its outliers. Factset reports that the energy sector has reported the biggest earnings upside in the quarter, beating consensus EPS estimates by an average of 17.7 percent. On the revenue front, utilities stocks averaged the biggest beat at 5.2 percent above Wall Street consensus. Under Armour (ticker: UA, UAA), Incyte Corp. (INCY) and Valero Energy (VLO) all beat consensus estimates by more than 85 percent. American International Group (AIG), Loews Corp. (L) and Yum Brands (YUM) have been the biggest earnings losers of the quarter, each missing estimates by more than 55 percent.
Guidance has been weak.
While fourth-quarter numbers weren’t great, most investors and analysts are much more concerned about 2019. For 2018, S&P 500 companies are on track to finish the year with 20.1 percent EPS growth and 8.9 percent revenue growth. Looking ahead, analysts are projecting a 2.2 percent earnings decline in the first quarter and revenue growth of just 5.3 percent. The good news is that analysts are expecting EPS growth to bounce back to a positive 1 percent in the second quarter, even as revenue growth slows further to 4.7 percent.
Numbers should be solid this year.
One of the biggest concerns rattling the market in the fourth quarter was the potential for an earnings recession in the first half of 2019. An earnings recession is two consecutive quarters of year-over-year EPS declines for the S&P 500. However, as of now, analysts are expecting earnings to bounce back a bit in the second quarter and finish 2019 on a strong note. Overall, analysts are targeting 4.8 percent EPS growth and 4.9 percent revenue growth for full-year 2019. That revenue growth rate is actually slightly above the long-term average of 3.4 percent growth.
Stocks are getting expensive.
After the 2019 rebound, stocks are once again looking relatively pricey from a valuation standpoint. The S&P 500 forward price-earnings ratio is relatively high at around 16 compared to its 10-year average of 14.6. However, it’s slightly below its five-year average of 16.4 thanks to the impressive earnings growth U.S. companies have experienced in recent years. Unfortunately, that forward P/E ratio has been trending in the wrong direction. The S&P 500 is up 11 percent since the end of December, but consensus 2019 EPS estimates are down 1.2 percent in that time.
Analysts see upside for stocks.
Despite projections of slowing growth in 2019, analysts are expecting a strong year for investors in 2019. The S&P 500 is already up 11 percent so far this year, but the consensus year-end price target for the S&P 500 is around 3,058. Based on recent levels, that target suggests the S&P 500 could have another 9.8 percent upside this year and could finish the year up roughly 22 percent. That large gain would come as a relief to investors, especially after the index finished 2018 down more than 6 percent.
Lessons learned from quarterly earnings reports.
Here are seven things that investors can take away from the fourth-quarter earnings reports:
— There were plenty of red flags.
— Investors are shrugging off the bad numbers.
— Some companies had a huge quarter.
— Guidance has been weak.
— Numbers should be solid this year.
— Stocks are getting expensive.
— Analysts see upside for stocks.
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