As Q4 2023 earnings season winds down, we exit 2023 and look ahead to next year. Using data from the latest , 2023 earnings growth for the S&P 500 is currently forecasted at 4.2%.
2023 proved to be a positive result if we compare to expectations at the start of 2023, where the earnings growth rate was close to 0% and many participants were expecting an earnings recession. As we look ahead to 2024, the earnings growth rate is expected to rise by 9.5%.
In this note, we decide to look further out and get a sense of analyst expectations on earnings growth over the next three to five years, which will be referred to as LTEG (long-term earnings growth expressed as a compounded annualized growth rate). Using LSEG Datastream, we can plot the LTEG for the S&P 500 using Datastream Charting, which is accessible in LSEG Workspace.
The LTEG for the S&P 500 sits at 18.8%, which ranks in the 97th percentile (since 1985) and well above the long-term average of 12.5%. The estimate has risen by nine percentage points over the last year, something we have not seen since the 2020 pandemic when the economy came to a halt.
However, we are in very different circ*mstances today where the economy has remained resilient over the last year when looking at the labor market and the health of the consumer. As a result, we may be able to attribute the rise in earnings growth expectations to a combination of a) expectations of a soft landing, and b) exceptional results from the Magnificent Seven who are beneficiaries of secular trends including artificial intelligence.
It is also worth noting an interesting observation when comparing LTEG to nominal GDP growth. Traditional economic theory would imply that earnings growth should follow the path of nominal GDP growth over the long run, yet the LTEG forecast appears to be biased upwards with a long-term average of 12.5%. This compares to a long-term nominal GDP average of 6.5% going back almost 80 years.
Exhibit 1: S&P 500 LTEG
Next, we dive underneath the hood of the S&P 500 to look at the LTEG estimate for each individual company and compare it to the forward P/E to assess growth vs. valuation. Exhibit 2 displays the LTEG for each constituent on the x-axis along with the forward P/E on the y-axis. Each bubble is color-coded to map to a sector and the bubble size is determined by the company’s market capitalization.
We can see many bubbles in the top right quadrant highlighted green, which represent constituents in the Information Technology sector. This highlights the valuation premium assigned to many companies in this sector who have high expectations set from an earnings growth perspective. We also see three bubbles in orange, which represent Communication Services and two of the companies in the Magnificent Seven (Alphabet and Meta Platforms).
The Mag-7 has an aggregate forward four-quarter P/E of 30.1x compared to 21.1x for the broader index. When we exclude Mag-7, the P/E declines to 18.7x. Currently, Alphabet (GOOGL.OQ) is the only company in the Mag-7 that has a forward P/E less than the overall index (19.8x).
Exhibit 2: S&P 500 P/E vs. LTEG
Perhaps the enthusiasm shared by analysts and the wider market can be justified when looking at the Mag-7 compared to the S&P 500. For the last few quarters, the Mag-7 as a group have materially outperformed the broader index from an earnings perspective in 2023.
Using data from the S&P 500 Earnings Scorecard, the Mag-7 delivered earnings growth of 43.1% in 2023 compared to 4.2% for the broader index. When we exclude Mag-7, the earnings growth rate drops to -1.2% as shown in Exhibit 3.
According to analyst estimates, we expect another year of Mag-7 earnings outperformance in 2024, albeit by a smaller magnitude.
Exhibit 3: Magnificent Seven Earnings Growth
For now, it appears that analysts have set a high watermark for earnings growth over the next three to five years. Using LSEG Workspace, we can see where analyst sentiment is currently most bullish (and bearish) for the S&P 500 using an industry group classification using LSEG StarMine data as shown in Exhibit 4.
The Analyst Revision Model (ARM) is a stock ranking model that is designed to predict future changes in analyst sentiment by looking at changes in estimates across EPS, EBITDA, Revenue, and Recommendations over multiple time periods. The model also incorporates the Predicted Surprise which can be viewed as a complimentary signal (i.e. strong analyst revisions combined with a positive Predicted Surprise creates a more robust signal).
Software & Services as an aggregate ARM score of 79, which represents a percentile score (1-100) with higher scores being bullish. This group contains companies including Microsoft and Salesforce, who have an ARM score of 94 and 88 respectively.
Semiconductors & Semiconductor Equipment also has a bullish aggregate score of 74, led by Nvidia who has an ARM score of 95.
On the bearish side, Automobiles & Components has the lowest aggregate ARM score of 16, which is driven by Tesla who has an ARM score of 4. Within Energy, both Exxon and Chevron have an ARM score of 14 and 6 respectively.
Exhibit 4: Analyst Revision Model Aggregate Scores
Source: LSEG Workspace
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