EPS Guidance Looks Spectacular

Q4 2017 earnings are shaping up to be great. These results support this bull market. There are many investors who argue that earnings don’t matter. There is always going to be short term action which doesn’t work in concert with earnings growth, but that’s not a sufficient argument to say earnings don’t matter. There could always be a recession which knocks down stocks before earnings growth shows the weakness, but recessions don’t occur often and earnings growth isn’t the only aspect we look at when investing. To further the first point, if a recession lasts for 1 year every 8 years, there are about 2 years (25%) of earnings results which aren’t useful. The earnings growth in the year before the recession is too optimistic and the earnings declines during the recession are too pessimistic. If you understand this, you can better grasp how to utilize this metric.

Anyone can look at a metric wrongly, which is often at face value, and say it has no value. Investing takes analysis which is often not straight forward, since every economy and company has a unique wrinkle. To further the second point, future earnings justify stock values, but they don’t always predict prices because guidance often misses recessions until they are so close that stocks have already fallen in sympathy of the economic weakness. This is why I look at all economic stats and a few key indicators with a good forecasting record.

With that understanding of the importance of earnings, you know how to interpret the latest data on Q4. As you can see from the chart below, 127 firms had positive annual EPS guidance from December 31st to February 15th. This is the largest annual increase since at least 1996, which is when FactSet started this calculation. The 2017 S&P 500 bottom up EPS estimates have increased 7% since December 31st. The estimates went from $147.22 to $157.57. The expected earnings growth coming into Q4 was 11%; now the blended estimate is 15.2%.