Earnings Provide Positive Surprise Despite Pandemic

Jacob Hess

February 18, 2021

• Earnings
• Outlook

Earnings season is more than halfway over as companies continue to report on full-year financial results for 2020. Executives have been busy quantifying the effects of COVID-19 on business operations while looking to an optimistic 2021. Reports have come out for 74% of S&P 500 companies as of February 12th, 2020.

Results so far have been positive with FactSet reporting that 80% of companies beat EPS estimates and 78% beat revenues estimates. If that rate continues, it will be the 3rd highest rate of positive EPS surprises since 2008. Not only have there been more positives surprises, but they have come at a higher rate. The 15.1% average positive surprise margin has been well above the 5-year average of 6.3%. On an annual basis, S&P 500 earnings growth is expected to be at 2.9%. This would be the first positive rate since 2019 Q4 and the largest positive rate since 2018 Q4.

So far, the strongest sector has been communications services with firms in that sector reporting positive EPS and revenue surprises 95% of the time. Information technology, financials, and industrials have all been above average with EPS beat rates above 80%. Struggling sectors were real estate, energy, and utilities. Real estate and energy only saw positive EPS surprises 67% and 55% of the time respectively. Utility companies overall have reported revenue below estimates 86% of the time.

Based on forward estimates of earnings, the S&P 500's price-to-earnings ratio sits at 22.2x, slightly lower than the 22.4x reported at the end of 2020. The Forward P/E is well below the Historical P/E of 39.9x as analysts are expecting a huge recovery in earnings in 2021. In 2021 Q1 and 2021 Q2, earnings are expected to rise 21.2% and 49.4% respectively only to drop to growth between 10-20% in the last two quarters. For the full year, projected earnings growth is 23.6%. Based on this information, the S&P 500 index is expected to increase 11.4% over the next 12 months.

One thing that is driving positive earnings so far is a high net profit margin. At 10.9%, S&P 500 companies are reporting a net profit margin above the 5-year average of 10.5%. The boost in profitability is likely a result of stimulus money to businesses and consumers that is fueling huge jumps in consumption and retail sales. However, firms are also reporting increasing input prices with many measures of producer inflation rising (PMI "prices paid" measures, import-export prices, and PPI). This could put pressure on 2021 net profit margin if companies are not able to pass rising costs on to consumers.

Overall, full-year 2020 earnings have helped the argument for current equity prices. Broad-based positive surprises in both earnings and revenue have suggested that stimulus has been at least somewhat successful in reflating the economy. Expectations for 2021 are huge, though, and rely on vaccinations and stimulus to move in the right direction. One thing does seem certain... 2021 is going to be a better year than 2020 in many, many ways.