Earnings Estimates Look Too High. That’s Bad News for the Stock

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Earnings estimates—and stocks—have risen recently. But considering what companies are saying, and how long cost pressures could persist, all that could potentially change. 

This earnings season has felt much better to investors than many had anticipated. Earnings-per-share estimates for 2022 for component companies of the

S&P 500 index
have risen 0.26% in the past month, according to FactSet. Helping drive those higher forecasts has been much better-than-expected earnings; the aggregate EPS beat for S&P 500 companies has been 15%, according to Credit Suisse. To be sure, financials have driven much of that, beating estimates by 22%, while other sectors have posted narrower beats. In the past month, the S&P 500 has gained 2.9%, including an earnings-season pop to start October.

But profit estimates now seem to be overly optimistic. First off, Bloomberg has published about 9,000 third-quarter profit-warning stories, according to Bank of America. That’s the third-highest count for a quarter since 2011 and the two times it was higher, S&P 500 earnings estimates were revised lower for the following quarter. Companies are grappling with supply-chain constraints, which hamper companies’ ability to meet sales expectations and cause costs to rise, pressuring profit margins. A labor shortage is bringing wages higher, also pressuring margins.

“We see increased headwinds heading into the third quarter, primarily driven by supply chain issues, delta-driven slowdown, and continued inflationary pressure,” writes Savita Subramanian, head of US equity and quantitative strategy at BofA Securities.

Those challenges indicate that Wall Street is too optimistic about profit margins. Analysts expect net margins—excluding financials—to rise to 12.6% in 2022. That would be up from third-quarter net margins estimates of 12%, which are now slightly below the second quarter’s result. That’s largely because of cost and labor inflation. Meanwhile, companies have mentioned “inflation” on third-quarter reports more than any other time in almost the past two decades, with mentions up 900% year-over-year, according to Bank of America. These factors suggest that, if those issues persist, profit margins are likely to disappoint next year. 

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