Q1 Earnings Season Recap: Corporations continue to draw the gross margin levers
As Q1 earnings season draws to a close, we reflect on the primary issues discussed in our Q1 earnings preview. First, we questioned whether earnings would surpass low expectations, given analysts' projections of a modest 3% year-over-year increase—the weakest growth since the COVID-19 pandemic. Second, we examined the progress of AI: its impact on results and the ability of companies to monetize this technological revolution. Lastly, we considered the resilience of consumer spending. Entering earnings season, equities faced some pressure, with the S&P 500 reaching an all-time high of 5333 on April 1 before experiencing profit-taking. The index dipped to 4963 on April 19 due to escalating geopolitical tensions between Israel and Iran. However, equities have nearly recovered all those losses over the past four weeks, partly buoyed by better-than-expected earnings results. In this report, we delve into the key themes and company performances from Q1. One thing is certain: U.S. corporations continue to demonstrate their ability to pull levers to maintain profits, much to the interest of investors. As of May 15th, 461 companies of the total S&P 500 market cap, reported their Q1 results. Among these companies, 60% exceeded earnings by at least one standard deviation of analyst estimates, well above the 15-year average of 48%. Conversely, 10% missed earnings by at least one standard deviation, slightly below the 15-year average of 13%. Initially, consensus expected EPS growth of 3% for Q1, but with the reporting season nearly complete, EPS growth is now tracking at +6% year-over-year. The 3% earnings beat falls short of the historical average of 4% but still provides a boost to analysts' earnings expectations. This is significant because the S&P 500 is currently trading at about 21 times earnings, which is a historically high valuation for the index. Have you heard of AI? The subject of Artificial Intelligence remains a white-hot issue on the conference calls. Companies have been rewarded by investors when they highlight a plan to use AI to either improve efficiencies internally or for outside customer experience. "AI-centric" companies have outperformed the S&P by approx 19% on average. This has not been lost by management teams as they were sure to mention any connection they have with the technology. 41% of S&P 500 companies mentioned AI in their Q1 2024 earnings calls compared to 23% a year ago. The AI trade is expanding, especially to companies needed to support AI technology, such as data centers and utilities. Nearly 70% of S&P 500 energy companies mentioned AI in their earnings calls, compared to 19% last quarter. Information Technology sector still leads in AI mentions, rising slightly to 87% in Q1 2024. In their earnings calls, IT firms discussed increased demand for their AI products, plans for further infrastructure investment, and strategies for monetizing their AI offerings. Outside of IT, companies are also discussing internal AI applications to enhance productivity and improve existing products. Margin Expansion Continues Margin expansion is crucial for companies as it directly impacts profitability and shareholder value. By increasing margins, companies can enhance their earnings without necessarily boosting sales, making their operations more efficient and resilient. This is particularly important in volatile economic environments where cost control and efficiency gains can provide a competitive edge. Additionally, higher margins can attract investors, as they often indicate a company's ability to manage expenses, exercise pricing power, and sustain growth. Ultimately, margin expansion contributes to stronger financial health, enabling companies to reinvest in their business, innovate, and drive long-term success. This quarter, the average earnings surprise has been 11%, while the average sales surprise has been 1%, indicating that margins have been the key driver of better-than-expected earnings. In response to rising input costs in 2021 and 2022, companies have taken steps to protect their margins and enhance profitability. While firms previously highlighted their pricing power, this quarter, they have focused on managing expenses and controlling costs. We expect that profitability will remain a key focus for companies as long as there is uncertainty regarding the timing and extent of policy easing. The Consumer Watch One of the goals of raising interest rates is to slow down the economy, which is necessary for the Fed to control inflation. However, this also tends to cool the job market and can potentially lead to layoffs. There are already signs that the labor market is being affected by these higher rates. For investors, the key question is how this impacts consumer spending, which accounts for approximately two-thirds of the U.S. economy and is a critical factor that cannot be overlooked. Elevated gas prices and higher interest rates as factors contributing to soft consumer confidence, with a noticeable shift towards more value-oriented products. While banks, which have a broader view of consumer behavior, are still report strong consumer spending and healthy balance sheets, consumer-facing companies are more cautious. Many of these companies observe that consumers are becoming more discerning and are opting for lower-priced products. Walmart ($WMT(WMT)), the World"s largest retailer, highlighted this in-depth on its call yesterday. Additionally, companies are increasingly focusing on the affordability of their products and services. However, certain segments, such as cruise lines, airlines, and entertainment companies, continue to report strong consumer demand. During the Q1 earnings season, 83% of Consumer Staples companies posted positive earnings surprises, the highest among all sectors. The Consumer Staples sector has also risen by 6% over the past month, outperforming the S&P 500's 2% gain and ranking as the second-best performing sector behind Utilities (+11%). The proportion of S&P 500 consumer-facing companies mentioning affordability during quarterly earnings calls has increased by 20% year-over-year. Summary of S&P 500 Q1 Earnings and Revenue Surprises by Sector S&P 500 Overall - Earnings: 75% Positive, 20% Negative - Revenue: 34% Positive, 19% Negative; Average Q1 Revenue Surprise: 1% - Quarterly Performance: -1.0% - P/E Valuation: 21.7x Consumer Staples - Earnings Surprise: 86% Positive, 7% Negative - Revenue: 55% Positive, 17% Negative; Average Q1 Revenue Surprise: 0% - Quarterly Performance- 6.93% - P/E Valuation: 18.96x Health Care - Earnings: 85% Positive, 13% Negative - Revenue: 57% Positive, 43% Negative; Average Q1 Revenue Surprise: 3% - Quarterly Performance: 0.78% - P/E Valuation: 18.54x Information Technology - Earnings: 78% Positive, 20% Negative - Revenue: 43% Positive, 29% Negative; Average Q1 Revenue Surprise: 2% - Quarterly Performance: 5.44% - P/E Valuation: 25.10x Industrials - Earnings: 77% Positive, 21% Negative - Revenue: 33% Positive, 24% Negative; Average Q1 Revenue Surprise: 1% - Quarterly Performance: 6.26% - P/E Valuation: 19.01x Consumer Discretionary - Earnings: 74% Positive, 21% Negative - Revenue: 28% Positive, 24% Negative; Average Q1 Revenue Surprise: 0% - Quarterly Performance: 2.12% - P/E Valuation: 18.21x Communication Services - Earnings: 74% Positive, 21% Negative - Revenue: 23% Positive, 23% Negative; Average Q1 Revenue Surprise: (4)% - Quarterly Performance: 12.40% - P/E Valuation: 18.00x Real Estate - Earnings: 71% Positive, 23% Negative - Revenue: 32% Positive, 26% Negative; Average Q1 Revenue Surprise: 2% - Quarterly Performance: 1.10% - P/E Valuation: 28.48x Materials - Earnings: 61% Positive, 36% Negative - Revenue: 14% Positive, 37% Negative; Average Q1 Revenue Surprise: (5)% - Quarterly Performance: 9.51% - P/E Valuation: 15.08x Financials - Earnings: 59% Positive, 41% Negative - Revenue: 37% Positive, 18% Negative; Average Q1 Revenue Surprise: 3% - Quarterly Performance: 6.95% - P/E Valuation: 13.33x Energy - Earnings: 57% Positive, 43% Negative - Revenue: 18% Positive, 32% Negative; Average Q1 Revenue Surprise: (5)% - Quarterly Performance: 9.56% - P/E Valuation: 10.13x Utilities - Earnings: 61% Positive, 27% Negative - Revenue: 32% Positive, 29% Negative; Average Q1 Revenue Surprise: (3)% - Quarterly Performance: 16.12% - P/E Valuation: 16.04x