MBLY - Q4 Earnings Season: Look Out For Deteriorating Guidance In 2024

2024-01-07 11:31:42 ET

Summary

• The quarterly earnings season for Q4 2023 is set to begin, with high expectations for strong corporate earnings to justify current market valuations.
• Earnings estimates for Q4 have been deteriorating, but forecasts for calendar year 2024 remain robust, fueling optimism in the stock market.
• Corporate profit margins remain robust and overall market valuations are not overextended, providing support for the stock market.

By Andrew Prochnow

The onset of the new year brings an immediate challenge for the stock market, with the commencement of the quarterly earnings season for the final three months of 2023 set to unofficially commence on Friday, January 12. During this period, some of the nation's largest financial institutions are slated to unveil their Q4 earnings figures.

The upcoming earnings season has assumed added significance, given the robust rally that propelled the stock market to close 2023 on a high note. This surge has heightened expectations for Q4 earnings, as sustaining all-time highs in the stock market seems improbable if the forthcoming earnings reports fall short of optimistic projections.

The substantial year-end market rally was significantly influenced by the Federal Reserve's recent policy shift. In its latest meeting, the Fed adopted a more dovish stance, hinting at the possibility of up to three rate cuts in 2024. This shift is undeniably favorable for the corporate sector, as lower rates typically translate to enhanced profitability.

However, strong corporate earnings are likely necessary to justify current market valuations. Additionally, any forward guidance provided for the calendar year 2024 will play a pivotal role in shaping the trajectory of the stock market moving forward.

Case in point, Mobileye ( MBLY ) announced on Jan. 4 that its earnings outlook for Q1 2024 had weakened significantly as a result of slowdown in customer orders (i.e. softening demand). Shares of MBLY traded 25% lower in the wake of that disappointing earnings guidance.

Looking at another example, shares of Apple ( AAPL ) were recently downgraded by Barclays. In an associated research note , Barclays noted that sales for the iPhone 15 line have been "uninspired" of late. Year-to-date, shares in Apple are down about 3%.

Traders should also note that shares of JP Morgan Chase ( JPM ) recently climbed to fresh all-time highs. And if the company's Q4 earnings report doesn't provide a good reason for ongoing optimism, it's easy to see how the stock could pull back after earnings.

Q4 Earnings: Current Outlook

At present, earnings estimates for Q4 are rather modest. According to data compiled by Zacks , earnings for the S&P 500 are expected to clock in roughly +0.1% higher than the same period last year.

That's well below the earnings growth observed in Q3 2023, when earnings for the S&P 500 were up 3.4% as compared to a year earlier.

Earnings estimates for Q4 have been deteriorating of late. In early October, Q4 earnings for the S&P 500 were expected to grow by more than 5%. But in the interim, analysts have been cutting back their expectations for Q4 earnings, as illustrated below.

The present projections for Q4 earnings growth may not be particularly appealing. Yet, estimates provide one perspective, and the actual figures are a different matter altogether. Should Q4 earnings growth surpass expectations, it could significantly validate the recent upswing in stock prices.

Conversely, a scenario where earnings fall below expectations doesn't necessarily guarantee a downward pull on the market. This is due to the fact that forecasts for calendar year 2024 earnings have remained relatively robust, despite the decline in expectations for Q4.

According to FactSet , corporate earnings for the S&P 500 are expected to grow by nearly 12% during 2024. And that figure is well above the 10-year average, which is closer to 8.4%. Interestingly, the majority of that rosy outlook appears to be concentrated in Q4 of 2024, when earnings are expected to jump by an eye-popping 18.2%.

Looking at the first three quarters of 2024, FactSet is projecting earnings growth of 6.8%, 10.8% and 9%, which are also fairly robust figures.

Considering that backdrop, one can see how some investors and traders might be willing to look past a lukewarm earnings season in Q4 of 2023. Because at this time, it's the promising earnings growth in 2024 that's arguably been fueling recent optimism in the stock market.

There are a couple caveats to the current outlook. If Q4 2023 earnings season is significantly worse than expected, that could shake investor confidence in the 2024 forecasts. And that negativity could be compounded if a large number of companies lower their full-year 2024 earnings projections, as observed recently with Mobileye.

Corporate Profit Margins

A detailed analysis of the upcoming earnings season reveals that expectations for Q4 2023 are rather modest. Instead, it appears that bullish investors and traders have pinned their hopes on a strong rebound in corporate earnings growth in 2024. Whether that comes to pass, is still anyone's guess.

That said, the market does have a couple things going for it-corporate profit margins remain robust, and the stock market's overall valuation doesn't appear overextended. As a result, investors and traders are likely to "wait and see" whether corporate earnings grow as expected, rather than adopting a defensive position at this time.

In Q3 of last year, the average corporate profit margin for companies in the S&P 500 was about 11.6%. That's down from the recent peak, which was closer to 13%. However, it's also above the 5-year average, which is closer to 11.0%

Moreover, the current profit margins in the S&P 500 are well ahead of the average levels observed prior to the pandemic, as illustrated below.

Corporate profit margins are currently projected to surge back toward record highs during the second half of 2024. That outlook dovetails well with the aforementioned projections on favorable earnings growth.

Overall Market Valuations

Analysts are currently expecting corporate earnings to grow by over 18% in Q4 of this year. If that type of growth does materialize, one could see how associated profit margins would likely skyrocket, as well.

Either way, 11.6% profit margins-as observed last quarter-are robust in their own right, which has undoubtedly served to help justify current valuations in the stock market. And at this time, valuations in the stock market are far from inflated, despite the surge in prices at the end of 2023.

At present, the forward price/earnings (P/E) for the S&P 500 is hovering around 21. That's down from the recent peak of 23, and only slightly higher than the longer-term average of roughly 18.

During the last 10 years, the P/E for the S&P 500 has ranged between roughly 18 and 40, which suggests that the current reading of 21 is far from extended. The only caveat is that the forward P/E relies heavily on aforementioned 2024 earnings projections, which may be overly optimistic.

At the end of the day, it appears that if corporate earnings keep up with expectations in 2024, the market could continue to rally, or at worst, trade sideways. But if 2024 earnings guidance starts to waver, and the P/E ratio for the S&P 500 starts to climb, that could trigger a correction in the stock market, bringing valuations in line with the revised expectations.

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