Investing.com - The second quarter earnings season will kick off in earnest over the two weeks, and the strong results in the previous quarter have set consensus expectations very high, according to Goldman Sachs (NYSE:GS).
Will Companies Beat Earnings Targets in Q2?
The most recent earnings season saw an above-average number of S&P 500 companies reporting positive earnings surprises.
The year-over-year earnings growth rate in the S&P 500 was 5.4% in Q1, the highest growth rate reported by the index since Q2 of 2022.
This has raised the expectations bar for the upcoming Q2, with Goldman Sachs stating that consensus expects +9% year/year EPS growth, which would mark the strongest quarterly growth rate since the fourth quarter of 2021.
“We expect S&P 500 firms will again clear the bar set by consensus estimates,” analysts at the influential investment bank said, in a note dated June 28. “However, the magnitude of earnings beats is likely to diminish as consensus forecasts set a higher bar than in previous quarters.”
Expected EPS growth of +9% contrasts with the minimal growth expected at the starts of recent earnings seasons, and consensus estimate revisions have recently been unusually resilient, the bank added.
Consensus quarterly EPS estimates are typically reduced by 7% during the six months prior to the start of the reporting season, but during the last six months, the consensus 2Q EPS estimate has been cut by just 1%.
“This embedded optimism suggests that the average EPS beat of +8% during the past four quarters will be difficult to match during the upcoming reporting season,” Goldman said.
Earnings are likely to decline in only the Materials and Industrials sectors, while Information Technology and Communication Services are expected to deliver the fastest EPS growth at the sector level, led by the mega-cap tech stocks.
AI Stocks EPS Goals
As in other recent quarters, the six largest stocks in the index–Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOGL), Meta Platforms (NASDAQ:META), Microsoft (NASDAQ:MSFT) and Nvidia (NASDAQ:NVDA)–are likely to be the biggest growth drivers, with these six on aggregate expected to grow 2Q EPS by 30% year/year while the other 494 stocks in the S&P 500 to grow by 5%.
However, even these mega-cap AI-related tech stocks (leaving Apple out of this equation) will report a slowdown in sales growth and four will also have a contraction in net margins.
Sales growth for the five stocks is forecast to slow from 22% year/year in 1Q to 17% in 2Q, and further to 15% in 3Q and 14% in 4Q, while Nvidia’s sales growth is expected to slow from 262% year/year in 1Q to 110% in 2Q, 72% in 3Q, and 55% in 4Q.
In contrast, sales growth for the median S&P 500 stock will be accelerating, albeit from a slower rate (year/year growth of 2%, 3%, 5% and 5%, respectively).
Earnings Calendar Dates Q3
The quarterly earnings season really starts on July 11, with soft drinks giant PepsiCo (NASDAQ:PEP) and packaged foods company Conagra Brands (NYSE:CAG) due to report.
The major banks kick things into top gear the following day, with Bank of New York Mellon (NYSE:BK), Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) all releasing results at the end of next week.
The mega-cap AI tech stocks will start reporting in late July, while investors will have to wait until Aug. 23 for the numbers from market favorite Nvidia.
Stock Valuations in 2024
Despite the expected deceleration in mega-cap tech profit growth, the valuations of these massive stocks generally remain high.
Although the expected slowdown in sales growth sets a low bar for the group’s results, EV/sales valuation multiples have increased by 28% year-to-date.
If consensus estimates are realized, the Q2 reporting season will be an important test of whether investors are willing to pay the same valuation premium for the group, especially as the EPS growth differential between the mega-caps and the rest of the market is forecast to narrow significantly in 2H 2024 and 2025.
The five mega-cap tech stocks trade at 8x EV/sales, compared with 3x for the median S&P 500 stock.
“History shows that growth stocks with high valuations face asymmetric downside risk from failing to meet consensus expectations,” said Goldman Sachs.
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