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Darren415 By Tajinder Dhillon Earnings season kicks off this week and will provide further insight to a myriad of questions – will a greater percentage of companies miss earnings expectations? Will there be continued pressure on profit margins? Will forward earnings expectations continue to reset? Using data from the January 24th publication of the STOXX 600 Earnings Scorecard, 22Q4 earnings are forecasted at €125.1 billion (+9.5% y/y, -7.6% q/q) while revenue is forecasted at €1,380.8 billion (+0.9% y/y, -11.5% q/q). Furthermore, analysts have aggressively downgraded both earnings and revenue growth expectations heading into earnings season. Earnings growth has decreased by 6.2 percentage points (ppt) heading into earnings season, which highlights how analysts have lowered expectations and lowered the bar for companies this quarter. This compares to a long-term average decline of 0.3 ppt and a prior four-quarter average increase of 3.4 ppt. The decline in earnings expectations heading into earnings season marks the first decline in seven quarters and the largest decline since 2020 Q2. 22Q4 y/y earnings growth peaked in November 2022 (+20.9%, +9.8% ex-energy) which has since dramatically declined as shown in Exhibit 1. This marks a ‘reset in growth expectations’. Exhibit 1: STOXX 600 22Q4 Earnings Growth Rate From an earnings contribution perspective, the financial sector is currently forecasted to contribute 6.8 ppt towards the index growth rate of 9.5%. Energy (5.7 ppt) and Consumer Cyclicals (2.9 ppt) are the next largest contributors while Basic Materials (-3.4 ppt), Utilities (-1.5 ppt), and Technology (-1.2 ppt) are the largest detractors to earnings growth this quarter (Exhibit 2). Four sectors are expected to have a positive earnings contribution in comparison to six sectors having a negative earnings contribution this quarter. Exhibit 2: STOXX 600 22Q4 Earnings Contribution Exhibit 3 looks at the difference between ‘market-cap’ and ‘share-weighted’ weights for the STOXX 600 sectors. The STOXX 600 Earnings Outlook utilizes a share-weighted methodology as opposed to a traditional market-cap weighting. Energy has a 6.6% market cap weight in the STOXX 600, yet it’s expected to deliver almost a quarter of earnings this quarter. Energy has a 22Q4 earnings share weight of 22.1%, creating the largest positive gap between share weight and market-cap weight of all sectors (15.5 ppt), which highlights the reliance on Energy to deliver earnings this quarter. The Energy sector also has a 20.3% revenue share weight, which is 13.7 ppt higher than its market-cap weight. Conversely, Consumer Non-Cyclicals has a market-cap weight of 13.0% compared to an earnings share weight of only 3.1%, which is the largest negative gap (-9.9 ppt). Exhibit 3: Market Cap vs. Share-Weight for STOXX 600 Sectors Which companies have seen the largest revisions heading into earnings season? Using the Screener app in Refinitiv Workspace, we can screen for yet-to-report constituents that have seen the largest upgrades and downgrades heading into earnings season. Exhibit 4 highlights companies that have seen earnings downgrades of at least 30% as defined by the 60-day mean estimate change in ‘EQ1 Preferred Earnings’. Preferred Earnings is defined as EPS for most companies except for Real Estate where it can be either EPS or FFOPS depending on analyst coverage. Subsea 7 SA (OTCPK:SUBCY) (SUBC.OL) has seen the largest downgrade in EPS estimates over the last 60 days (-444.4%) followed by Credit Suisse Group AG (CS) (CSGN.S, -186.7%), AB Electrolux (OTCPK:ELUXF) (ELUXb.ST, -162.2%), Covestro AG (OTCPK:CVVTF) (1COV.DE, -77.1%), and Orsted A/S (OTCPK:DNNGY) (ORSTED.CO, -74.4%). Note: values less than -100% indicates that the consensus mean estimate turned from a positive to negative value. Exhibit 4: Largest Negative Revision for 22Q4 Source: Refinitiv Workspace Exhibit 4 also displays the Predicted Surprise (PS) for each constituent, which compares the SmartEstimate vs. Mean Estimate. A PS greater than 2% or less than -2% is deemed significant as our research shows that StarMine will accurately predict the direction of the earnings surprise 70% of the time. The StarMine SmartEstimate is a quantitative analytic which is used as an input to many of the StarMine models. The SmartEstimate places a greater weight on higher ranked analysts who are more accurate and timelier. We see a positive correlation between constituents that have seen a large downgrade and a corresponding negative PS. Furthermore, a positive correlation is shown between the mean estimate change vs. Analyst Revision Model (ARM) score (i.e., companies that have seen large downward earnings revision also have a low ARM score). ARM is a percentile stock ranking model that is designed to predict future changes in analyst sentiment by looking at changes in estimates across EPS, EBITDA, Revenue, and Recommendations over multiple time periods. The last two columns display both the current ARM score and its 30-day change. Looking at the Predicted Surprise and ARM columns can be very useful during earnings season to assess the likelihood of whether companies are expected to beat or miss earnings while at the same time gauging analyst sentiment. Exhibit 5 displays the same data for constituents with the largest upgrades heading into earnings season. Exhibit 5: Largest Positive Revisions for 22Q4 Source: Refinitiv Workspace Net profit margins slowly declining The forward 12-month net profit margin for the STOXX 600 is currently 9.8%, down from its all-time high of 10.1% in November 2022 according to Refinitiv Datastream and has increased by 170 basis points (bps) over the last two years as shown in Exhibit 6. Every sector except for Consumer Staples and Materials has seen a rise in profit margin over this period with the largest gains seen from Energy (+520 bps), Financials (+330 bps), and Consumer Discretionary (+210 bps). Exhibit 6: STOXX 600 Net Profit Margin If companies highlight margin pressure this quarter, we expect margin expectations to further decline and filter through into the bottom-up EPS estimate for the index. As per Refinitiv Datastream, forward 12-month EPS estimates have increased 14.4% to $35.6 per share while the STOXX 600 has declined 6.8% over the same period (-10.7% in USD), contributing to a large gap between ‘P’ vs. ‘E’ (Exhibit 7). More striking is the trajectory in the forward 12-month EPS ex. Energy estimates ($16.2 per share), which has declined 19.2% since last February. Exhibit 7: STOXX 600 Forward P/E Decomposition Conclusion Markets are looking to companies to provide commentary on several issues from the macro outlook, health of the consumer, impact of inflation and higher input costs, hiring plans, and the strength of the U.S. dollar which will generate tailwinds for companies with international revenue exposure. Supply chain pressures have eased when looking at Fed Surveys as indicated by faster deliveries to factories and a reduction in order backlogs. Given the host of worries noted above, we may see an increase in companies either a) withdrawing forward guidance, or b) lowering forward guidance which will bring further downward revisions to earnings and revenue estimates. Original Post Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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