Indiana Trust Wealth Management
Investment Advisory Services

by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, rose 1.8% this week.
  • Equity research analysts – industry specialists who track public companies – are revising earnings expectations down for the fourth quarter. What does that portend for stock prices?

The most important driver of returns on stocks is earnings growth. The present value of expected future earnings – whether “future earnings” are estimated using EPS, free cash flows generated, economic profits, or any alternative metric – is what gets baked into stock prices.

There is an army of industry specialists at asset management firms and brokerages following every step public companies take, scrutinizing management decisions, and analyzing firms’ financial data, in order to formulate earnings expectations.

These specialists, known as “equity research analysts”, are constantly sifting through data and looking for new approaches, and thus often must publish revisions to their expectations when new information emerges about a company, an industry, or the overall economy. The flow of information vital to forming earnings expectations is incessant. 

Bespoke Investment Group recently aggregated equity analyst revisions for the S&P 500 index of the largest companies in the US stock market. Revisions heading into this earnings season – when public companies disclose their performance for the last three months of 2023 – have been heading lower. Currently, 5.4% of companies in the S&P 500 are witnessing downward analyst revisions, net of those receiving upward revisions to expectations.

It may seem counterintuitive, but this “negative spread” of more firms with negative earnings revisions than those with positive revisions has portended good stock market returns through earnings season. Per the chart below, in only 18 (the red dots) out of the last 59 quarters did revisions move in the same direction as the market. When revisions are negative, returns have typically been positive. The vertical blue line represents the current negative spread of revisions:

Source: Bespoke Investment Group, January 2024

When the bar is lowered, it makes it easier for companies to beat expectations. If that does occur, stock prices tend to react favorably as earnings results are released. (This concept of lowering expectations for happier results makes intuitive sense to your author, a lifelong Chicago Bears fan.)

Companies obviously want to beat earnings expectations, but these quarterly “beats” and “misses” do not matter much for long-term investors. Firms beating expectations do not provide much information on where earnings are coming from or where they are necessarily going. The 4th quarter of 2023 will likely prove this to be true: despite more firms with negative earnings revisions than those with positive revisions, overall earnings will likely be near all-time highs. These developments do provide some context for short-term price moves as companies report results, although other factors – economic data, the Fed, etc. – can swamp the impact from earnings releases.


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