Earnings Estimates are ‘Likely Too Optimistic’, Risk Not Fully Reflected

By Senad Karaahmetovic

Goldman Sachs strategist Ben Snider believes that consensus profit margin estimates have more room to contract, he told clients in a note today.

The strategist sees profit margins declining next year whether or not we have a recession.

“Our model points to a 70 bp EBIT margin decline next year for the typical S&P 500 company in our economists’ non-recessionary base case, and a 130 bp compression in a recession scenario. In contrast, analyst estimates show the median stock’s EBIT margin expanding by 60 bp next year,” Sinder told clients in a note.

More importantly, Snider believes the market is still not “fully reflecting” the downside risk to earnings estimates, which are “too optimistic.” Goldman sees the median stock’s expected 2023 EPS growth from +10% to 0%.

“The decline this year has been driven entirely by falling valuations, which in turn have moved in line with rising interest rates. As a result, the equity risk premium remains close to where it started the year. While rotations within the equity market have signaled expectations of slowing growth, index valuation does not appear to be providing a buffer for the uncertainty around the path of future earnings,” Snider added in a note.

As a result, Goldman Sachs strategists are telling clients to continue focusing on stocks with good earnings visibility, “including firms with stable growth and the Health Care sector, which has grown earnings in each of the last several recessions.”