What To Watch As Fourth-Quarter 2023 Earnings Season Begins

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After breaking the string of year-over-year earnings declines in the third quarter, expectations are for another quarter of modest growth this earnings season. Earnings are slated to increase by 1.3% year-over-year, and topline sales are expected to grow by 3.1%. While the pace of inflation has moderated, the ability of companies to protect profit margins will be closely scrutinized. As investors look ahead to 2024 earnings, forward earnings guidance will be crucial.

Eight S&P 500 companies are scheduled to report earnings on Friday to kick off the earnings season, but the primary focus will be bank earnings. There are a handful of other companies on Friday’s calendar, like Delta
DAL
Air Lines (DAL), BlackRock
BLK
(BLK), and UnitedHealth (UNH). Among the banks reporting are JPMorgan Chase
JPM
(JPM), Citigroup
C
(C), Bank of New York Mellon
BK
(BK), Wells Fargo
WFC
(WFC), and Bank of America
BAC
(BAC).

According to FactSet, while the consensus year-over-year earnings estimates for financials call for a decrease of 3.1%, the banks within the sector are expected to post a more severe decline of 21%. The pace of loan growth has been weak, which could weigh on earnings. Deposit pricing should weigh on net interest margins. Credit losses have been normalizing, so the banks will likely increase reserves to prepare for future losses. Investment banking revenues likely remained relatively modest. On a more positive note, the wealth management business should have benefitted from strong markets. Outside the banks, insurance companies should post strong earnings growth with benefits from easier comparisons, improved loss ratios, and higher yields.

The communications services sector should report the most robust year-over-year earnings growth at 41.6%. Meta Platforms
FB
(META) is expected to be the most significant contributor to the increase, as the company faces easy comparisons and improved earnings again. The consumer discretionary sector is expected to post outsized year-over-year earnings growth at 23% again. This increase is primarily due to AmazonAmazon” data-type=”stock”>
AMZN
.com (AMZN), which is expected to grow year-over-year earnings per share from $0.03 to $0.80. Since Amazon is over 20% of the total market capitalization of the sector, its results have an outsized influence on the industry. According to FactSet, if Amazon were excluded from the calculation, the consumer discretionary sector would expect a slight year-over-year decline in earnings for the quarter.

Healthcare sector earnings should be dented by three pharmaceutical companies: Pfizer
PFE
(PFE), Merck (MRK), and Moderna (MRNA). According to FactSet, if these three drug companies were excluded from the calculation, the healthcare sector would only expect a 1.2% year-over-year decline in earnings rather than a whopping 20.3% plunge.

Oil and natural gas prices are lower year-over-year, resulting in the most significant expected decline in year-over-year sector revenues for the energy industry. With the contraction in sales, energy companies are also likely to have the largest year-over-year decline in earnings this quarter. The same phenomenon of energy prices and revenues also impacts the materials sector, which is expected to see poor results this season.

The reduction in energy costs hurts the revenues of the energy sector but positively impacts the costs for many non-energy companies. Labor costs will be a headwind for companies but have also moderated, with average hourly earnings rising at a 4.1% year-over-year rate in December.

Despite the continued plunge in profits due to lower oil prices, two of Berkshire Hathaway’s (BRKA, BRKB) largest publicly traded stock holdings are Occidental Petroleum
OXY
(OXY) and Chevron
CVX
(CVX
CVX
). According to recent filings, Berkshire had amassed an almost 28% stake in Occidental as of December. A previous piece discussed why Warren Buffett’s Berkshire Hathaway probably favors Occidental Petroleum.

Sales growth is typically closely tied to nominal GDP growth, combining after-inflation economic growth (real GDP) with inflation. Nominal GDP growth had been decelerating year-over-year, but solid economic activity in the fourth quarter should support revenue growth. This economic growth supports the consensus estimate of a 3.1% year-over-year sales increase for the S&P 500 and should provide some upside.

Unfortunately, some of the past nominal GDP growth was inflation rather than actual growth. Inflation has been trending lower since mid-2022, which should help earnings again this quarter. Inflation can threaten unit sales and pressure companies to raise prices or risk lower profit margins as their costs rise.

Looking at the differential in price growth for producer’s inputs (PPI) versus the price increases hitting consumers indicates some relief on profit margins. The better-expected topline sales growth, helped by solid economic activity in the quarter, combined with some easing of margin pressures, allows the opportunity for earnings to outperform the year-over-year growth expectations.

The U.S. dollar should also provide some relief for multinational companies. With approximately 40% of the sales of S&P 500 companies coming from international sources, the dollar weakness provides a relative profit boost to companies selling products internationally.

The modest expectations of slight year-over-year earnings gains for the fourth quarter seem likely to be exceeded. As we have now turned the page on our calendars, much attention will be paid to management’s future earnings guidance. The consensus earnings growth expectations for 2024 are 11.8% year-over-year growth, so it will be notable how that number changes as managements provide updated forecasts.