Look beyond the many third-quarter earnings beats and you may quickly start to question the quality of those numbers.
FactSet reports that 70% of companies that have reported so far have beaten earnings estimates, in line with historical norms. That’s despite a fair amount of disappointments in the tech sector over the past week.
The trouble is, only 42% of those companies have also beaten sales estimates, the lowest percentage of companies to beat revenue goals at this point in the quarterly reporting cycle since the first quarter of 2009 — the depths of the stock market decline.
The revenue misses could be sending a warning about future earnings troubles.
If it weren’t for such historically high profit margins (read: cost cutting and the benefit of historically low interest rates), more companies may have disappointed on the bottom line.
According to research by the SEC along with academics at Baruch College, Carnegie Mellon and Georgetown:
- Companies that report sustained increased in both earnings and revenue that higher quality earnings. That is, the earnings are more persistent, have less susceptibility to being manipulated in the short term, and have higher future operating performance.
- Earnings growth supported by strong revenue is likely to be more sustainable than earnings growth supported through cost reductions.
- Revenue is thought to be more difficult to manipulate than earnings, so it may be a more reliable trend indicator.
So it potentially raises a red flag when a historically large number of companies are beating on the top line, but disappointing on the bottom line.
That’s the case so far with the Q3 reports.
