Earnings Season – Reward for Beating Has Fallen
Last year, we repeatedly noted the tendency for companies that beat earnings estimates to subsequently outperform the index, and those that miss tending to underperform. This observation especially held true during the Q3 earnings season, as the reward for companies that beat earnings expectations was higher during the Q3 earnings season than at any time during the prior three years.
The Q4 earnings season has been underway for a few weeks now. While it is still early, the market is rewarding companies that beat estimates to a much smaller degree (see Fig. 1). In particular, the market is no longer applying an historically large premium to companies that report earnings that beat expectations.
Fig. 1 – Reward for Companies Beating Earnings in Q4 Has Shrunk
Source: S&P, FactSet, Bloomberg, Fundstrat analysis.
So far in Q4, the reward to companies beating earnings has been 1.1% in the three days following announcement (see dark blue bar at right in Fig. 1). That figure more in line with the historical average and implies that while the market still places a premium on companies whose results surpass expectations, that premium is less than half of the excess return assigned to companies that beat estimates in Q3 (2.7%).
Stock-Specific Risk Still on the Rise
We track a model that estimates the degree to which stock performance is driven by idiosyncratic characteristics (see Fig. 2). The model measures, for each stock, the degree to which the overall market and the sector to which the stock belongs drive overall its returns.
When this figure is high (More Stock-Specific) it means that stocks are generally being driven more by issues particular to individual companies. In such an environment, stocks exhibit more difference in their returns, and successful stock pickers can generate more alpha.
Fig. 2 – Stock-Specific Drivers are Becoming More Important
Source: S&P, FactSet, Fundstrat analysis.
After reaching a low in August of 2022, the degree of idiosyncratic risk among stocks increased through the rest of the second half of last year. So far in 2023, the trend toward more differentiation across stocks has continued. Should this trend persist, stock pickers would see a favorable environment for generating alpha.
Conclusion
After rewarding earnings beats to a degree not seen in several years during the Q3 earnings season, the advantage conferred by the market on earnings beats has fallen in Q4. However, the degree to which stock-specific risk drives overall stock returns continues to rise. Should these trends continue, stock pickers would see a favorable environment for generating alpha.
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