US public companies are required by the Securities Exchange Commissions (SEC) to report quarterly (every three months) earnings results. These earnings reports let investors examine the health of a company: including profitability, balance sheet strength, progress on their financial goals, and potentially for commentary on their outlook. Earnings results and company outlooks are widely used by investors to make decisions on whether to buy or sell companies.

While we believe that earnings results are an important factor in company analysis and stock selection, it is not the only tool to make buy or sell decisions. Other factors that influence the direction of stocks include:

• Inflation
• Interest rates
• Gross Domestic Product (GDP) growth
• Company valuation
• The position of the business cycle (expanding, contracting, peaking, troughing)
• Sector-specific opportunities and threats

Corporate earnings are one way to dissect a company, but in aggregate, earnings can also provide information on market trends and future growth. For example, the fourth quarter (Q4) earnings “season” officially just finished and earnings for the full year of 2022 are now complete. For the S&P 500, 2022 earnings per share (EPS) finished at $218.94,¹ up 5% from the prior year.  The historical and future earnings estimate for the S&P 500 are shown in the chart below.

Investors focus on earnings forecasts for 2023 and 2024 to gauge the growth of the companies that comprise the market.  Currently, the estimates are for slight growth of 2% in 2023 and for growth to reaccelerate in 2024 to above 10% (shown in green in the chart above). While a 2% growth rate in 2023 is below long-term averages, estimates continue to reflect growing earnings with the potential for reacceleration in 2024.

Another aggregate picture of the market is to look at the number and magnitude of “earnings surprises” – which is the number of companies exceeding the estimates made by stock analysts. Taking a closer look at the chart below, it reflects that companies regularly beat earnings estimates. However, the magnitude of companies beating can vary over time. In Q4 of 2022, the level of positive earnings surprise (1.1%) was the smallest amount in the last 13 years².

The reason this level of surprise is important is that stock prices react to both positive and negative earnings surprises. Stocks that have a significant positive surprise often see their prices go up, and vice versa for companies that miss their estimates. Interestingly, despite the lower than usual level of increases, stock price performance based on an earnings beats were better than average³ (seen in the chart below).  We believe the better stock reaction was, in part, due to the fact investors feared that Q4 earnings results would be even worse than what stock analysts were estimating.

Now that 2022 earnings are complete, investors will continue to look forward to judging whether it is a good time to invest in the stock market. Gradient Investments believes the stock market, over longer periods of time, tends to follow the trajectory of corporate earnings growth. While estimates for 2023 are for low growth, 2024 could create some level of future excitement if the double-digit earnings growth estimates remain intact.

1. Factset Earnings Insight
2. Yardeni Earnings Surprises
3. Bespoke Earnings Reaction