3 Reasons Why Earnings Expectations Are Way Too Low

It’s officially earnings season, with the world’s major companies already reporting how their fourth quarter of 2013 fared.

For his part, RBC’s Jonathan Golub believes that analysts are underestimating how good earnings will be. From his recent note:

Historical Precedence: Bottom-up EPS estimates imply 6.6% YOY growth in 4Q. However, history indicates that results will come in meaningfully higher. More specifically, actual reports have topped forecasts in each earnings season throughout the recovery, with an average beat of 3.2% over the past 2 years. As the exhibit below highlights, such a beat in the current earnings season would result in 9.9% growth.

Better Economics Not Reflected in Guidance: Over the past six months, forward- looking economic indicators, such as ISM, have ticked up. This is also reflected in an upturn in RBC’s Economic Surprise Index. However, despite this recent improvement, corporate guidance remains quite negative, holding down analyst forecasts.

Analysts Underestimate Earnings Around Turning Points: Economists forecast a 2.3% YOY increase in GDP in 4Q. This is a pickup from a pace of only 1.3% earlier in the year. Our research indicates that changes in GDP have a leveraged impact on EPS. History shows that analysts tend to underestimate this leveraged relationship. As a result, earnings beats tend to be larger during periods of economic acceleration, or rising ISM.

And check out the chart:

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