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Q3 Earnings Season Preview

It is no longer news that the overall corporate profitability picture is very strong.

Not only have growth rates been in record territory, but so have total aggregate earnings, with 2021 Q2 aggregate earnings for the S&P 500 index reaching a new all-time quarterly record, surpassing the record set in the first quarter of the year. Other positives in the earnings picture include the breadth of strength across all the key sectors and the notable momentum on the revenue front.

We also know that the unusually high growth rates of the first two quarters will not continue in the last two quarters as they largely reflected easy comparisons to the year-earlier periods that were severely impacted by Covid-related disruptions. Comparisons will be relatively normal in Q3 and beyond since the U.S. economy began reopening in the year-earlier period, hence the expected deceleration in the growth pace.

You can see this expected growth deceleration in the below chart that puts 2021 Q3 earnings and revenue growth expectations in the context of where growth has been in the preceding four periods and the estimates for the following three quarters.

Image Source: Zacks Investment Research

The comparable picture on an annual basis is no less impressive, as you can see in the chart below.

Image Source: Zacks Investment Research

As we mentioned earlier, the aggregate 2021 Q2 earnings tally represented a new all-time quarterly record. You can see that in the chart below, with this year’s four quarters highlighted.

Image Source: Zacks Investment Research

We all know that large segments of the economy, particularly in the broader leisure, travel and hospitality spaces are held down by the pandemic, with companies in these areas still earning significantly less than they did in the pre-Covid period. In fact, many of these companies aren’t expected to get back to pre-Covid profitability levels for almost another year.

The impressive feature of the record earnings in each of the last two quarters is that they were achieved without help from these key parts of the economy.

Clouds on the Earnings Horizon

The reality of corporate earnings is that the picture has not been this good in a very long time. The question is whether this strength continues in the coming periods or starts fading going forward?

The market appears bullish that the trend continues in the coming periods as well, but there are some worrying signs that require careful monitoring. The most important of these is the revisions trend. The chart below offers us a sense of how estimates have evolved for 2021 Q3.

Image Source: Zacks Investment Research

What we see here is that while the trend remains positive, it seems to have stalled out since late July. In fact, the magnitude of positive revisions to Q3 estimates are notably below what we had seen in the comparable periods of the last three earnings seasons.

This loss of momentum is likely tied to the emerging economic slowdown, which, in turn is likely a function of the Delta variant.

We also need to keep an eye on the margins outlook, given the rising cost trends in labor, inputs, freight/logistics and other line items.

The market appears to agree with the Fed’s assessment of this trend being ‘transitory’ and a function of Covid-related disruptions that eventually even out. This view is reflected in current consensus estimates, as you can see in the chart below.

Image Source: Zacks Investment Research

This ‘transitory’ view of the ongoing cost pressures is even more pronounced in the annual view of the margins picture, as the chart below shows.

Image Source: Zacks Investment Research

We all know that the ‘transitory’ or otherwise debate has implications for Fed policy, which is as important for the market as the outlook for earnings and margins.

Earnings Reports This Week

We have two S&P 500 companies on deck to report results this week. These are Copart CPRT and Kroger KR, with both getting counted as part of the 2021 Q3 tally. Other notable reports coming out this week include Lululemon Athletica LULU, Restoration Hardware RH, and GameStop GME.

For a detailed look at the overall earnings picture, including expectations for the coming periods, please check out our weekly Earnings Trends report >>>>Can Earnings Continue to Improve?

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The Kroger Co. (KR): Free Stock Analysis Report
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Copart, Inc. (CPRT): Free Stock Analysis Report
RH (RH): Free Stock Analysis Report
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