Key Takeaways
- Wall Street has set its expectations for third-quarter earnings too low, according to David Kostin, lead U.S. equities analyst at Goldman Sachs.
- Modest expectations may set the stage for stocks to rise as the majority of S&P 500 companies report earnings later this month.
- Analysts increased earnings estimates throughout the third quarter, the first time since late 2021 that Wall Street has grown more optimistic about earnings over the course of a quarter.
Investors could be in for pleasant surprises this earnings season.
According to David Kostin, the top U.S. stock market analyst at Goldman Sachs, Wall Street is underestimating the economy’s strength and setting the bar too low. The consensus among equities analysts is that S&P 500 earnings growth slowed to 6% in the third quarter from 11% in the second.
“We expect earnings growth will surpass this forecast, as usual, due to stronger sales growth than consensus expects and positive surprises from the Magnificent 7,” Goldman analysts led by Kostin said in a recent report.
Why This Matters To You
Individual stock prices are based on many factors, but two of the most fundamental are earnings growth and valuation. With stocks currently trading near record highs and valuations elevated, companies may need to impress Wall Street with their earnings to justify and increase their stock price.
Another quarter of better-than-expected earnings could help sustain the market’s momentum through the end of the year, which is historically the best time for stocks.
Resilient Economy, Mag 7 May Drive Earnings Beats
Wall Street estimates real sales growth slowed to 1% from 2.5% in the previous quarter, but Kostin believes that’s too conservative a view in light of recent economic data. Goldman economists estimate GDP grew 2% in the third quarter, about in line with second-quarter growth.
If sales growth is substantially weaker than in the second quarter, it may be attributable to less-favorable foreign exchange rates. The value of the U.S. dollar slid throughout the first half of the year, boosting the value of the S&P 500’s international sales. With the dollar stabilizing in the third quarter, that tailwind likely dissipated.
Kostin believes Wall Street is also underestimating the Mag 7, the tech mega-caps that have been the main drivers of S&P 500 earnings growth for the last three years. Analysts forecast the group’s earnings grew half as fast in the third quarter as they did in the second. Wall Street was expecting a similar slowdown last quarter, according to Kostin. Instead, the Mag 7 handily beat estimates.
Earnings Estimates Raised for the First Time in Years
Expectations may be lower than is warranted in Kostin’s view, but analysts are still more optimistic about earnings than they were three months ago.
Analysts, in aggregate, raised their S&P 500 earnings per share estimate by 0.1% between the beginning and end of the third quarter, according to FactSet Research Senior Earnings Analyst John Butters. This marks the first time since the fourth quarter of 2021 that analysts have grown more confident about earnings over the course of the quarter.
Analysts increased their estimates during the last earnings season in July and August, as a series of trade deals and strong earnings reports helped clear the fog of uncertainty around tariffs and their impact on the bottom line. Kostin warns against expecting a repeat this month.
“With little recent change to the outlook for tariffs or the economy, we expect much more modest revisions this quarter,” he wrote.
Kostin also expects tariffs to be a bigger headwind for earnings this quarter. Customs duties totaled $93 billion, up 33% from the second quarter. Corporate America’s profit margins were likely stable due to tariff mitigation strategies like supplier changes and cost cuts, says Kostin, “but substantial margin expansion in 3Q appears unlikely.”
