By John Butters, Senior Earnings Analyst
08 July 2016 02:16 pm
As of today, the S&P 500 is expected to report a year-over-year decline in earnings of 5.6% for the second quarter. What is the likelihood the index will report an actual earnings decrease of 5.6% for the quarter?

Based on the average change in earnings growth due to companies reporting actual earnings above estimated earnings, it is likely the index will report a smaller decline in earnings than 5.6%. However, based on this average, the index is still likely to report a year-over-year decrease in earnings for Q2.

How Surprises Impact Earnings

When companies in the S&P 500 report actual earnings above estimates during an earnings season, the overall earnings growth rate for the index increases because the higher actual EPS numbers replace the lower estimated EPS numbers in the calculation of the growth rate. For example, if a company is projected to report EPS of $1.05 compared to year-ago EPS of $1.00, the company is projected to report earnings growth of 5%. If the company reports actual EPS of $1.10 (a $0.05 upside earnings surprise compared to the estimate), the actual earnings growth for the company for the quarter is now 10%, five percentage points above the estimated growth rate (10% – 5% = 5%).

Over the past four years, on average actual earnings reported by S&P 500 companies have exceeded estimated earnings by 4.0%. During this same time frame, 68% of companies in the S&P 500 have reported actual EPS above the mean EPS estimates on average. As a result, from the end of the quarter through the end of the earnings season, the earnings growth rate has typically increased by 2.7 percentage points on average (over the past four years) due to the number and magnitude of upside earnings surprises.

Related: EPS Estimate Cuts Smaller Than Average for S&P 500 in Q2

If this average increase is applied to the estimated earnings decline at the end of Q2 (June 30) of -5.4%, the actual earnings decline for the quarter would be -2.7% (-5.4% + 2.7% = -2.7%). If the index does report a decline in earnings for Q2, it will mark the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since Q3 2008 through Q3 2009.