Show of hands: who’s looking forward to earnings season?
Although the increasingly permabull-ish punditry is fond of plotting earnings growth with the S&P in a largely fruitless effort to “debunk” what they swear to Christ is a “conspiracy theory” about central bank largesse leading directly to gains in global risk assets, the irony is that these very same pundits overwhelmingly think there’s little utility in paying attention to fundamentals.
After all, it’s the very same people who persist in the whole “it’s the earnings growth not the QE” fantasy that will tell you to keep buying at historically elevated multiples via passive index funds which, by virtue of being passive index funds, indiscriminately funnel your money into the market with no regard whatsoever for the fundamentals. Maybe the pundits can explain that rather glaring inconsistency in what for them counts as “logic.”
Anyway, that turned into an agitated rant (who’s surprised?). The whole reason I sat down to pen this brief post was to point out that, as Goldman writes on Friday evening, “consensus expects S&P 500 y/y EPS growth of 10% in 4Q, a rebound from the 7% growth in 3Q [and] ex-Energy, S&P 500 earnings are expected to grow by 8% versus 4Q 2016.” Here’s the chart:
Here’s the thing though. According to Goldman, you should probably just go ahead and ignore Q4. I mean, obviously they don’t put it in quite those terms, but that’s the gist of it. To wit:
We expect investors will largely look through 4Q results and focus on the impact of tax reform on 2018 EPS. The Tax Cuts and Jobs Act was signed by President Trump on December 22, 2017. As a result, companies are likely to take certain charges this quarter and the noisy 4Q results will muddy underlying company fundamentals. Furthermore, many analysts may exclude these one-time charges from adjusted EPS. For companies only reporting GAAP EPS, the headline impact could be substantial
With that, here are the “two key sources of 4Q EPS uncertainty”:
- Companies will be required to write-down the value of deferred tax line-items. Firms will be forced to remeasure the value of their deferred tax assets and liabilities at the new 21% statutory federal corporate tax rate. Companies will record a tax expense (benefit) if deferred tax assets are greater (less) than deferred tax liabilities. Utilities, Telecom Services, and Energy would be the largest relative beneficiaries from the change, as their deferred tax liabilities exceed their deferred tax assets by the greatest amount relative to market cap. In contrast, Real Estate, Financials, and Info Tech stand to benefit the least. GM, AIG, GT, C, and NAVI have the largest net deferred tax assets as a share of market cap.
- S&P 500 firms will owe at least $275 billion in taxes on previously untaxed overseas cash and earnings. The tax bill’s deemed repatriation imposes a tax of 15.5% on untaxed overseas cash and 8% on untaxed overseas earnings. Info Tech has the largest stockpile of overseas cash and earnings and will owe $123 billion, accounting for 140% of consensus 4Q net income. AAPL will incur the largest tax bill of any company under the provision, owing $33 billion on its $216 billion of overseas cash. The Health Care sector will face the second largest bill (130% of 4Q net income).
Adjust your expectations accordingly.