Investors just witnessed “blockbuster earnings of the decade.”
That highly amusing description of Q2 reporting season comes courtesy of a Bloomberg article dated August 4.
Forgive me, but the quote (above) sounds like the awkward subject line of a clumsy, overseas phishing scheme. The only good thing about phishing emails is the comedic value. More often than not, they’re written by folks whose only motivation for learning English was to pen solicitations. So you get this: “Greetings of the day!” Or maybe this: “Blockbuster earnings of the decade!” And usually from somebody purporting to be a “Frank” or a “Julie.” As if any genuine “Frank” would greet his fellow suburbanites like that. “Happy morning, Bob! Blue skies of the year!”
Once you finish chuckling, note that the point of the linked Bloomberg piece was to highlight… well, “blockbuster” earnings, and also the fact that companies haven’t generally been rewarded for beats, stupendous though they may be.
The second quarter was always going to be superficially impressive. The comp was easy. A year ago, the US economy was (briefly) mired in the worst downturn in a century. A mere 12 months later, the same economy was roaring. Coming into Q2 reporting season, analysts expected S&P profits to rise more than 60% from the pandemic nadir. With nearly 90% of index market cap reporting, the actual figure is ~85% (figure below).
The granular breakdown is either impressive or else just indicative of the futility inherent in forecasting during a pandemic. Goldman’s David Kostin ran through the numbers in a Friday evening note. Nearly three-quarters topped consensus by at least a standard deviation of analyst estimates. Two-thirds beat consensus sales. That, Kostin noted, “compared with historical averages of 48% and 34%, respectively.”
He went on to say that “this quarter can be characterized not only by a large number of beats, but also the impressive magnitude of surprises.” Specifically, the average EPS surprise was 17%, nearly three times the historical average, while the average top-line surprise was almost six times the long-term trend.
Mostly, Q2 was a margins story. Overall, they (margins) improved more than 350bps compared to Q2 2020. 12.1% was a record and a full 100bps above forecasts.
Not surprisingly, Comms Services and Tech stood out (table on the left, above, from Goldman).
But more so than ever, it’s not about “What have you done for me lately?”, but rather about “What can you do for me going forward?”
In other words: The pandemic put an even higher premium on guidance, which had the effect of lowering the premium for last quarter’s results.
Indeed, the median outperformance for stocks beating estimates the following trading day was just 14bps this quarter. That may as well be nothing. The historical average is more than 100bps. By contrast, the reward for guidance (as a measuring stick, Goldman used an outlook that’s at least 5% above consensus) was 75bps.
In the linked Bloomberg article, Justina Lee cited Wells Fargo’s Chris Harvey, who attributed the lack of follow-through after beats to “sell-side forecasts [being] especially off the mark this year after a lack of corporate guidance amid the pandemic [and] strong results across a slew of companies and sectors desensitiz[ing] investors to [a] remarkable quarter.”
If margins are what matters, you might fairly ask whether things are about to get a lot more challenging. After all, cost pressures are rampant and many expect wage bills to rise further as labor remains in short supply.
On that front, Goldman’s Kostin wrote that “management commentaries suggest firms are relying on a toolbox of measures to combat the threat of margin compression, namely pricing and cost control.”
Unfortunately, I’m compelled to once again channel a “wise” man who, when faced with even the simplest of queries, habitually eschewed anything like reflection in favor of a more concise rejoinder: “We’ll see what happens.”
It’s interesting to me how easily prices on consumer goods have been raised. The only explanation that comes to mind is that people were so anxious to get access to their favorite stuff that they became insensitive to price increases. Some of the stuff I buy regularly has gone up 20% or more — fast. Companies are promising there is more to come. I am really amazed, perhaps naively, but the amount of margin expansion is bigger than it has been in my (aging) memory.
Unfortunately I think what I have seen a lot of is consumer goods scalping on anything with remotely limited stock. I think what it has demonstrated over time to certain companies is there is enough price insensitive demand that you can essentially stop worrying about fulfilling total demand. I recall reading a report a decade or so ago about how companies can really stop worrying about the bottom 70-90% of American consumers because they have no money anyway. If someone making $300k a year will buy your product at $400 the same as at $50… then make it cost $400 and make less of them. Who cares about being short of low margin business when you can survive comfortably on high margins. If you don’t have much buying power then you aren’t really important and if you do… well you’re pretty price insensitive.
There is a ‘double whammy’ in this price increase issue in that there is a simultaneous reduction in the quantity in packaging of virtually every product as sold . This likely increases the frequency of purchases.. Putting is simply , your kid is going to eat two one ounce candy bars just like he ate the single two ounce bar at the same price for each bar. That short packaging phenomenon alone throws ‘transitory inflation’ onto the sidewalk five floors below.