Earnings & Expectations - Key Call-Outs (Peak Forward Multiples)

04/26/16 08:46AM EDT

The Materials sector, and the S&P 500 as a whole, is going on its third consecutive quarter of negative Y/Y earnings growth, and forward expectations have been taken down (obviously on a lag). With the sector now trading at peak forward multiples, below we ask the question, are forward-looking earnings expectations now too beaten-down, or is the current peak multiple a sign to be cautious of prospective returns? We would argue the latter.

*Note*: The S&P 500 GICS Materials Index only has 27 companies, so we’ll take a deeper look at expectations and different multiples for a larger sample next week in our monthly “Sector Sentiment Run” slide deck.

  • Earnings Growth: With Materials sector earnings down -18% this reporting season to date (after printing -18% in Q4 2015), Q1 2016 would mark the 3rd consecutive quarter of negative Y/Y earnings growth (see chart below).
  • Case for Peak Multiples: Without question earnings expectations have been revised materially for the obvious reasons, especially in resource-driven sectors. Every sub-sector beat bottom line expectations in Q4 despite the fact that earnings declined -18% (the same level we are currently tracking for Q1 2016). With the 2-month move in Materials stocks, does the market have it right? – The sector is trading at cycle peak forward multiples. 
  • Earnings & Expectations: Earnings growth beat estimates by 16.9% in Q4 2015 despite declining -17.9%. However, every sub-sector beat top-line estimates in Q4. This trend has continued for Q1 2016. So are earnings expectations too low, or is earnings manufacturing by corporations at unprecedented levels? Either way, the sector is trading at a peak multiple 7 years into a bull market, which in reality could be a much higher on a comparative basis, and we question the catalyst to take the market to much higher multiples without a correction. Again, we’ll look at this next week with a larger sample of companies.

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - PE Chart

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - Q1 COmps

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - Q4 15 Comps

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