about 2 years ago • 3 mins
Fourth-quarter earnings season – when companies reveal how they’ve performed over the last three months and 2021 as a whole – kicked off last week, and expectations are high for one sector in particular…
✍️ Connecting The Dots
Over the course of the fourth quarter of 2021, analysts increased their earnings expectations for the members of the S&P 500. They now think US companies will report fourth-quarter profits 22% higher than the same time in 2020, driving more than 40% annual earnings growth.
Energy firms are expected to make headlines after a rebound in oil’s price: they’re forecast not just to have swung into a profit from a loss in the fourth quarter of 2020, but for those profits to have broken records. Other “cyclical” industries – whose fortunes tend to rise and fall with global economic growth – are set to announce bumper fourth-quarter earnings too: industrials are expected to see their earnings double from the year before, and materials companies’ profits are projected to grow by more than 60%.
Growth in every other sector is likely to come in below the S&P 500’s average, but a couple of sectors are expected to do particularly poorly: financials and utilities companies are both expected to show earnings declines in the fourth quarter, while consumer discretionary firms – which sell things shoppers want but don’t need – are anticipated to post disappointing profit growth of under 2%.
1. How to play earnings season.
Profit growth estimates and share price performance are already available to investors, which means they’re probably already reflected in current stock prices to some degree. But what’ll ultimately drive stocks’ performance is the implication of a company’s results – as well as of any earnings forecasts – on its future cash flow. Put simply, a company’s stock is likely to rise if last quarter’s results beat expectations, or if the company forecasts a stronger-than-expected quarter or year. If the opposite happens, its price should fall. Take Amazon: its fourth-quarter earnings growth forecast has tumbled 70% in the last few months, but only about 3 of its 510 million shares are being used to bet that its stock will fall – which makes sense given that it typically underpromises and overdelivers. That could make now could be a good time to buy its shares, along with the US stock market as a whole.
2. This year won’t all be smooth sailing.
Companies will also set out their profit expectations for 2022 this earnings season. At the moment, the S&P 500 earnings per share (EPS) estimate is $222.32 – the highest annual figure ever. Over the past quarter-century, however, the actual annual EPS has come in 7% lower than the forecast at the start of the year. If that pattern holds, you might find at various points in the year – particularly in earnings seasons – that a company’s stock price outstrips the value of its future earnings (remember, a stock’s value today reflects the average value assigned by investors to all a company’s future cash flows in the future). So if you notice its price-to-earnings ratios at eye-watering highs, it might make sense to trim the most expensive of your positions and lock in profits in case of a short-term “correction” in prices.
🎯 Also On Our Radar
A fresh report out last week showed that London-based tech startups raised almost $26 billion last year – double 2020’s total, and bringing the UK fourth behind the US, China, and India for venture capital funding. Some twenty new “unicorns” – startups worth $1 billion or more – were minted in the UK’s capital alone last year. But with shares of previous darlings Deliveroo and Wise having had a tough time since their public market debuts, investors might now take those high valuations with more than a grain of salt.
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