VettaFi Voices On: Winners and Losers in Q1 2023 Earnings Season

Market watchers have closely watched the Q1 2023 earnings season, seeking the first domino to fall in a looming recession. That hasn’t happened — yet. However, earnings still have plenty to tell us. This week, the VettaFi Voices gathered around the water cooler to sift through earnings results and look for clues about the remainder of this year.

Eyeing These ETFs in the Q1 2023 Earnings Season

Todd Rosenbluth, head of ETF research: As a former stock analyst, I covered tech and telecom companies earnings for a decade. Then I saw the growth of ETFs and made the shift. But earnings trends and valuations drive equity ETFs, which are really a collection of stocks. So in a way, I never really left.

Some ETFs focus specifically on EPS trends. The WisdomTree US Large Cap Fund (EPS), for example, tracks an earnings-weighted index. It weights Amazon (AMZN) less than companies with a more modest market cap, like Chevron (CVX) or Pfizer (PFE).

Meanwhile, quality ETFs focus on earnings trends, with a preference for consistency. One that comes to mind is the iShares MSCI Quality Factor ETF (QUAL).

Healthcare and technology companies seem to have had the strongest earnings season, relative to expectations. That will boost market cap-weighted sector ETFs, like the Vanguard Information Technology (VGT) and the Health Care Select Sector SPDR (XLV).

While second quarter earnings are trending higher than expected, which always happens due to analyst conservatism, the consensus still expected earnings declines for Q1 and AQ2. It seems like the second half is when a return to earnings growth is to be expected, despite fears of a recession.

Earnings Results in Disruptive Tech

Jeremie Capron, director of research at ROBO Global, a VettaFi company: About 70% of the portfolio companies in the ROBO Global Robotics and Automation Index have reported Q1 earnings. More than 80% of those prints came in above consensus estimates for revenue. The companies in the index saw first quarter aggregate revenue growth of about 10% year-over-year (YoY).

There were some issues with the semiconductor group, which is still in a downcycle. Recovery expectations have moved out to 2H. Pretty much everything else, however, has come in positive.

North America industrial automation showed very well, in sharp contrast to overall trends in manufacturing/cap goods. Rockwell Automation (ROK), the dominant player in factory automation control systems in the U.S., reported 27% organic growth in the quarter. You typically only see a number like that coming out of a nasty downturn. ROK’s long-term growth rate has been single digits, and last year they grew revenues by 10%.

China has returned in a big way, benefiting Japanese exporters of automation equipment into China. Fanuc (FANUY), the world’s leading provider of factory robots, received record high orders in the quarter.

Healthcare results came in encouraging, as the post-COVID hangover appears to be fading and organic growth [appears to be]picking up again. Intuitive Surgical saw a large beat and raise with robotic procedure growth of 26%, as discussed in the note earlier this week.

Warehouse automation also appeared to be looking better than any time in the past 12 months when the Amazon downshift in warehouse investments hurt the industry.

Midstream Earnings Strong, but Overshadowed

Rosenbluth: Stacey, how are things looking in energy infrastructure?

Stacey Morris, head of energy research: Despite the weakness in energy stocks lately, the sector saw broadly positive earnings results, including midstream. Most midstream names reported last week, and earnings reports generally exceeded consensus expectations. A few companies even raised financial guidance for 2023. The management teams shared very constructive outlooks.

Unfortunately, all the macro headlines last week obfuscated the strong midstream earnings season. Still, the space continues to execute well while providing attractive income. As of May 10, the Alerian MLP Infrastructure Index (AMZI),  which underlies the Alerian MLP ETF (AMLP), was yielding 8.3%, was yielding 8.3%.

Looking for Cost-Cutting Measures, Not Growth

Rosenbluth: Roxanna, you’re a kindred spirit: A former stock analyst who came to see the trend toward index-based investing. What’s standing out to you this season?

Roxanna Islam, associate director of research: Broadly speaking, I think it’s important to realize that there’s a difference between earnings beating analyst expectations and earnings beating YoY, like Todd said. So many factors can affect analyst expectations. Reluctance to take a negative view on companies under coverage or company management releasing conservative guidance can make an impact.

Companies can control revenue to an extent by controlling prices, but at a certain point it’s easier to control costs. We saw a lot of that over the past few quarters. Companies have been able to cut down on rent expenses and travel expenses with remote workers. They’ve also cut spending and, maybe most significantly, laid off a number of their workers. I think many analysts are starting to look for these cost-cutting measures rather than growth.

Companies can cut costs to satisfy Wall Street analysts, which is good for earnings beats and ultimately the stock price. Still, cost-cutting measures have to lead to better productivity gains, or there could be further earnings deterioration. I saw situations just like that while covering the railroads a few years ago. Analysts might like significant cost-cutting to boost operating margins on paper, but it can cause service and customer issues.

That gives us just one industry example, but it can apply to just about anything. In general, market watchers should consider earnings to be important, of course. They can move stock prices. In the long run, however, one good or bad quarter can’t tell much about a company. Many investors tend to take short-term views based on earnings.

How to Interpret Q1 2023 Earnings Reports

Rosenbluth: How do you think investors should think about interpreting earnings reports, then?

Islam: Let me offer some high-level takeaways. One, how does industry demand match up with company revenue and forward guidance? Two, even if management guidance is provided, don’t hesitate to form your own opinion. Three, revenue can technically grow almost infinitely, but cost-cutting can’t. If a company has been growing earnings metrics for several quarters solely from cost-cutting measures, then that may not be sustainable.

Four, if there are a lot of adjustments in the earnings report, do they make sense? Five, how is the earnings consensus distributed? While large-cap stocks can be covered by 30+ analysts, some smaller stocks have as few as one to three covering analysts. That may not be enough to come to a consensus.

Lastly, an earnings beat doesn’t necessarily mean the stock will react well. In some cases, investors are more cautious and don’t reward beats as much as previous quarters. Sometimes earnings will produce a beat, but with poor forward guidance. Sometimes the beat is significantly less impressive than earnings results from peers.

Standouts in Tech, Communication Services

Islam: As for specific sectors, I think big tech/communications earnings have been really important so far. Markets have rewarded the stock prices of several firms that beat expectations. This follows trends we’ve seen earlier this year with those two sectors being the best-performing out of the S&P 500. When those few large-cap stocks do well, the S&P does well. Investors grow to be more bullish on the stock market overall. They do so despite several other moving factors like the banking crisis, fears of recession, and Fed uncertainty.

I also think part of what is getting investors even more excited with big tech has been the relationship with artificial intelligence. As such, earnings figures themselves aren’t the only thing analysts and investors are looking for. They are listening to earnings season calls for any language regarding AI, which may foreshadow future growth opportunities.

Rosenbluth: I agree with Roxanna that tech and communications services companies have stood out. Growth index ETFs like the iShares Russell 1000 Growth (IWD) or the Vanguard Growth ETF (VUG) offer exposure there. However, according the FactSet EPS data tracker, financials have also proved to be relatively strong. This is a traditional value sector. The regional banking crisis has put financials in focus in recent weeks. However, a few weeks back, JPMorgan (JPM) produced a large revenue and earnings beat, and other large-cap banks did as well.

I also like to look at investor sentiment for the sectors based on what VettaFi traffic is trending. Since earnings season kicked off a few weeks ago, financials has led all the other sectors in popularity. The Financial Select Sector SPDR ETF (XLF) took in strong inflows in April, per LOGICLY data, though it has incurred redemptions in May.

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