By Wallace Witkowski, MarketWatch
As earnings season kicks off, historical averages point to the third quarter as the end of a year-plus earnings recession, but a recent scale-down of buybacks and profit warnings pose a challenge to that outcome.
U.S. stocks on Friday ended a three-week streak of gains as both the Dow Jones Industrial /zigman2/quotes/210598065/realtime DJIA +0.89% and Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +1.24% declined 0.4%, and the S&P 500 index /zigman2/quotes/210599714/realtime SPX +1.00% shed 0.7%, following a September jobs report that fell lower than consensus expectations.
Following a big surge in share buybacks in the first quarter—the same buybacks that boost earnings-per-share for many companies—the second quarter saw a pullback in such purchases, along with notable declines in the early third quarter. That’s significant heading into earnings season as the more companies reduce their share counts, the more of an EPS boost they receive, increasing the likelihood of an earnings surprise.
In the second quarter—the last quarter for which full data is available—the number of companies on the S&P 500 that had reduced their share counts enough to have a significant effect on earnings declined to 134 from 139 in the first quarter, according to figures from Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. Silverblatt said a share-count reduction of 4% or more significantly impacts EPS.
The lion’s share of those companies can be found in the tech sector, Silverblatt said. The tech sector is expected to report a 1.9% rise in earnings from the year-ago period, according to FactSet data. Earnings surprises from that heavily-weighted sector on the S&P 500 could serve to push the index to a gain for the quarter.
Companies that have reduced share counts by 10% or more
|Company/ticker||% share count reduction from Q3’15 to Q2’16|
|Quanta Services Inc. /zigman2/quotes/203420082/composite PWR||17.4%|
|H&R Block Inc. /zigman2/quotes/207406664/composite HRB||17.2%|
|American Airlines Group Inc. /zigman2/quotes/203700638/composite AIG||16.6%|
|Qorvo Inc. /zigman2/quotes/209919828/composite QRVO||15.5%|
|Motorola Solutions Inc. /zigman2/quotes/203308192/composite MSI||13.2%|
|Navient Corp. /zigman2/quotes/204528402/composite NAVI||12.5%|
|United Continental Holdings Inc. /zigman2/quotes/205037281/composite UAL||12.0%|
|Harley-Davidson Inc. /zigman2/quotes/207565294/composite HOG||11.4%|
|American International Group Inc. /zigman2/quotes/203700638/composite AIG||10.9%|
|TE Connectivity Ltd. /zigman2/quotes/205324491/composite TEL||10.9%|
|General Electric Co. /zigman2/quotes/208495069/composite GE||10.0%|
To get an idea of how close this earnings season is to the line between a loss and a win, consider this: Analysts have typically underestimated actual quarterly earnings performance by an average of 2.9% over the past four years, according to John Butters, senior earnings analyst at FactSet. When applied to earnings expectations at the end of the third quarter—a decline of 2%—that average underestimate, should it apply, would mean a 0.9% rise in S&P 500 earnings for the third quarter. Not spectacular, but then again, not a sixth consecutive quarter of earnings declines either.
The one drawback to this line of thinking is that the tech sector, where most of the buybacks are coming from, has also been the sector that’s seen earnings expectations rise in the third quarter. While the sector’s earnings are expected to rise 1.9% from a year ago, those expectations were for a paltry 0.1% rise at the beginning of the third quarter.
Another source of cold water thrown over earnings season may come from a recent slew of profit warnings from companies such as Honeywell International Inc. /zigman2/quotes/205583690/composite HON +0.40% , Ford Motor Co. /zigman2/quotes/208911460/composite F +2.83% , and General Mills Inc. /zigman2/quotes/206659526/composite GIS -0.74% , suggesting that expectations may have been too high going into this earnings season.
Notable earnings reports this week
|Report date||Company/ticker (FactSet EPS / revenue estimates)|
|Mon., Oct. 10||None scheduled|
|Tues., Oct. 11|
|Weds., Oct. 12|
|Thurs., Oct. 13|
|Fri., Oct. 14|