Earnings Season Was Surprisingly Surprising

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.

Are we wobbling here, Alexis? Is that what's happening with the stock market? I'm seeing the NASDAQ, uh, 3 pullbacks of more than 1% in the past 6 sessions. That's at the time of this recording. Is that a wobble?

It's not looking super steady.

Doesn't feel steady, but earning season has been good. I mean, it's been good bordering on great. It's always pretty good, but it's been really good. I'm thinking that buys us some time at least. I'll, I'll run through some of the numbers and folks can decide for themselves. This is the Barron Streetwise Podcast. I'm Jack Howe. With me, our audio producer Alexis Moore.

Hey, Jack.

We are almost 90% of the way through earnings season. There's this thing that happens 4 times a year where America's publicly traded companies report their financial results to investors. Basically, I compare it with having a dunk contest on lowered rims. In this case, what happens is analysts reduce their estimates as we get closer and closer to reporting time. And then companies announce their numbers and we all celebrate that they beat estimates. They were upside earnings surprises galore. That's what usually happens. That is happening this time, but to a greater extent than usual. If you go back to the beginning of this year, analysts were predicting 13% third quarter earnings growth for companies in the S&P 500. That's excellent growth. That was before the big tariff announcements. What was that? What did we call that again? Independence Day?

They called it Liberation Day.

Liberation Day. I don't know why I keep forgetting that. It's such a, it's such a description that draws the mind to tariffs. Okay, so we had the tariff announcements in spring and there were reciprocal tariffs and there were pauses and there were unpauses and analysts gradually reduced their growth estimates to the point where at the end of September, the end of the third quarter, the forecast was down to 8% growth from 13%.. And I think looking at the numbers that analysts took too much off because earnings beats have hit a 4-year high. That's both in the prevalence and the size of the beats. Third quarter results are 90% in. We're looking ahead over the next couple of weeks to a handful of big companies left. We're going to hear from Disney and Walmart and especially NVIDIA, which is, uh, November 19th, probably slated for November 19th. Don't hold me to that. But we're 90% of the way done. And the growth rate, in fact, is tracking toward 13%, more or less what analysts were looking for at the very beginning of the year before we started talking about tariff— I forget the name again— tariff liberation. So this is good news. The S&P 500 trades at 25 times earnings. That's expensive. So you need excellent earnings growth to make a price tag like that work. And I think we're getting it, at least for the third quarter. Tariffs have not hurt as much as expected. We might not be seeing the full effects yet. B of A says that judging by inventories, companies stocked up during a tariff pause that ran out in August. They write that those inventories are now likely depleted, so fourth quarter profit margins could be more telling. We won't hear about those until early next year. Companies could also get some support from a weak dollar. All else held equal, a 10% drop in the value of the dollar corresponds with an earnings boost of about 3%. But these are all minor details, tariffs and currency exchange. We're all piled into index funds right now, and our index funds are loaded up on big tech. And the market is expensive, which means there are two questions right now that matter more than all the others. Number 1, are artificial intelligence hyperscalers still showering each other and the tech sector and the broad market with cash in the form of their capital expenditures, their data center buildout? And number 2, do investors still seem to like that sort of thing? And the answers to those 2 questions are yes, and mostly. Microsoft, Amazon, Alphabet, and Meta Platforms, those 4 companies alone could combine for capital expenditures of $356 billion this year, up 56%, according to B of A. How much is $356 billion? It's close to adding a new Coca-Cola or Bank of America. It's a lot of money. It used to be the size of what we would call a giant company. So it's a lot. And it compares with CapEx for the rest of the S&P 500, all 496 other companies combined. Of $904 billion. That's up only 5%. So with these 4 companies increasing their spending by 56%, there's this huge new source of money that's being thrown around. And a lot of that money is being spent within big tech. And that's why earnings growth for big tech for the third quarter is tracking around 29%. It's a huge number. The rest of the index, Just 5%. That gives you a sense of the extent to which this bull market depends on this handful of companies continuing to kill it. But they can only do that if investors continue to like to hear that. They mostly seem to like it. Amazon is spending a ton. That stock jumped 10% after earnings. The company talked about very strong web services growth. That flows directly from its AI spending spree. So the money is paying off. Contrast that with Meta Platforms, whose CEO Mark Zuckerberg said, he said a lot of things, stuff about superintelligence, and I don't quite know what that is, but there's a timeline and maybe we'll get there and maybe it'll be soon, maybe not so soon, and you got to spend a lot of money in case we get there. I better let him tell you.

Now there's a range of timelines for when people think that we're going to get superintelligence. Some people think that we'll get there in a few years. Others think it will be 5, 7 years or longer. I think that it's the right strategy to aggressively frontload building capacity so that way we're prepared for the—

Zuckerberg somehow missed the mark despite all that super stuff about the intelligence, and those shares dropped 11%. That was the biggest drop in 3 years. So investors weren't having it with Meta spending, but by and large, they were receptive. To other companies. Okay, so growth is excellent. A lot of companies are beating estimates. Big tech is still spending a ton. I think you have to call the third quarter an earnings success, even though statistically the earnings beats, they resulted in pretty slim gains and the misses were punished fairly severely. That's more or less what you would expect from an expensive stock market. There are high expectations built in. I like to run my own screen of earnings day reactions. I do it a little different than Wall Street does it. What they do is they start with the upside earnings surprises and then they say, what did these stocks do in reaction to those surprises? What I do is I forget about the earnings surprises. I put them aside. Those are basically just saying that analysts guessed wrong and they usually guess wrong. So I don't care about how the reported results compared with the estimates as much as I care about what the stocks did in response. I just search for the price reaction. I view that as the real list of surprises. And there were plenty of super duper big ones. I looked in the S&P Composite 1500. That's an index with companies that are large and small. And I scan companies that have reported results since the beginning of October. And I found 106 companies that had double-digit percentage gains in response to earnings and just slightly more, 115, that had double-digit declines. That's a lot of earnings drama and much of it had relatively little to do with artificial intelligence, just in case you're sick of hearing about it. I'll run you through a few examples. Not all of these are representative of broader trends. Some of them are just company specific. One example is Trex. That's the company that makes composite decking. In other words, if you want to build a deck, you can go and use regular lumber, but then you're going to have to treat it or stain it or do something with it every year or two. You'd be better off buying pressure-treated lumber. That'll hold up better to the elements. But Trex has a composite lumber, and that's made basically by going around and collecting wood scraps like sawdust and combining that with recycled plastic. Like melted-down old shopping bags, and you turn that into a board that is much better at resisting the elements. It can last a lot longer without warping or rotting than even pressure-treated lumber. And Trex has made great money off that product for many years, but the stock has fallen into decline in recent years. That's because there's been a slump in housing activity. But after the company's latest earnings report, shares lost 31% in a day. And that doesn't seem to be just about the state of housing activity. It seems to have more to do with competition, as in rising competition. One brand that stands out is called TimberTech. It's owned by a big company called ASIC. TimberTech also makes composite lumber, but in addition to that, they make boards from polyvinyl chloride or PVC. That's the plastic used to make plastic pipes. In other words, they're taking Trex's idea one step further. Instead of mixing plastic and wood, they're getting rid of the wood altogether and just using plastic. And nobody wants a Fisher-Price-looking plastic deck, but TimberTech makes PVC boards that look like wood. I'm looking at a bunch of different colors here— weathered teak and English walnut and cypress and mahogany and dark hickory. And they're made in such a way that the grains are different from board to board, just like with real wood. And I guess customers like it because they're winning share. And that's a problem for Trex. Here's another company that took a beating, Newell Brands. They make Sharpie markers and Rubbermaid containers and Yankee Candles. And that one lost 28% after earnings. That stock had already been a decade-long loser. The latest decline is because the company raised prices in response to tariffs. It expected that its competitors would follow suit. They did not. And so during the crucial back-to-school selling season, I think if you're in the Sharpie business, that's when you move a lot of markers. Newell sales slumped. Now they're going to have to rethink their prices. You can contrast that with Winnebago. They don't make school supplies. They make recreational vehicles. But there's a comparison there with what happened with prices. Winnebago has also been in a slump, but that stock bounced 29% after earnings. It's because Winnebago used price increases to offset weak demand and some shift toward cheaper models. The price increases worked. They offset market weakness. I don't know that they can do that forever, but for now it makes Winnebago look like a company with pricing power, and investors like that. There were two trucking companies that had huge earnings gains. J.B. Hunt Transport Services, that's a fleet owner, that was up 22%, and C.H. Robinson Worldwide, that's a logistics company, up 20%. Trucking is another business that's been struggling. You find a lot of businesses that have been struggling when you get outside of artificial intelligence. Judging by freight volumes, the industry isn't seeing a turnaround yet. But these companies have done a lot of cost cutting and that's helped with earnings. There could also be a hit to capacity next year. There are new federal restrictions on commercial driver's licenses for non-US citizens. Anything that cuts into capacity could allow these companies to charge more. I'll give you a few more. Chipotle, that was an 18% decliner. The company blamed a burrito shortfall on young, low to middle income earners. Folks making less than $100,000 a year. It says they're struggling with student loan payments and slow wage growth. Wingstop reported a same-store sales decline and blamed pretty much the same thing, but that stock somehow gained 11%. Investors seem to like the company's plans for kitchen renovations and a loyalty program. General Motors gained 15% and Ford gained 12%. Demand for gasoline vehicles was healthy. The companies are losing money on electric vehicles, but they talked about plans to reduce those losses. What was that movie, Alexis? Who Killed the Electric Car? Remember that one from— I feel like there might be a sequel coming at some point. And finally, the biggest one-day price gainer of earnings season so far is Hertz Global Holdings. The rental company reported its first profit in 2 years.. It has a new bustling business selling cars out of its rental fleet. I mean, it's always done that, but what it's done is dump old cars onto wholesalers. Now it started more selectively selling vehicles through retail channels. There's better money in that. And that is a smattering of earnings day drama. There are a lot of names out there I'm skipping over. And I think what we're going to do now, Alexis, tell me if I'm right, answer a couple of listener questions, maybe. Possibly after taking a break. Is that the plan? That's the plan. That's coming up after this quick break.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.

Welcome back. Alexis and I were just having a chat about— welcome back, Cotter. You didn't know about Arnold Horshack or Freddie Boom Boom Washington or Juan Epstein or Vinnie Barbarino. All these names from my childhood. That's okay. It just— and you just found out that the show celebrated its what? 50th anniversary. Crazy. And I'm so young, which, how would I? It doesn't add up. We want to quickly answer a couple of listener questions, and they're not about the Sweathogs. It's a Welcome Back, Kotter reference. Who do we have, Alexis?

First up, we have Rolf from Alaska. He has a question about single stocks versus index funds.

Hey, Rolf, let's hear it. Hi, Jack. I was here in Alaska and it was starting to snow. And I was reading some books on index investing to pass the time. I have some different stocks, some of them up, some of them down, and altogether they're probably about even. I was thinking of selling them all and just sticking it in a total market fund. What do you think? Great to hear from Alaska and you, Rolf. This will be a short answer, I think. I can never quite tell. You have individual stocks, you're thinking about selling them and buying a cheap index fund. Should you do it? The answer is yes, absolutely. It sounds like you're not thrilled with your own stock picking. You wouldn't be nearly alone. Most people struggle to beat the stock market. Most people, in fact, who are paid to pick stocks for actively managed portfolios for the express purpose of beating the stock market also struggle to beat the stock market. And by the stock market, I mean the indexes behind those cheap index funds you're talking about. Take the S&P 500. Over the past decade, it has returned 281%. 100% is a double, 200% is a triple, so you've made almost 4 times your money in a decade. That's a lot more than usual. Works out to an annualized return of 14.3%. I don't know how many of us saw that coming, and I don't know how many predicted that it would be concentrated in the stocks that are leading the market today. Did you know early on that NVIDIA would evolve from a company that makes chips for video games to the most valuable company in America and the company on the receiving end of this AI investment boom? Even if you figured that out early on, is it possible that after that stock had run up a lot that you'd have been tempted to sell and maybe sell too early? NVIDIA over the past 10 years has made over 23,000%. Maybe at the 5,000% mark, you'd have said, you know what, it's been a pretty good run. Going to cash out here. If you're in an index fund, you don't have to make all those decisions. The market will figure out the weighting for you. You mentioned a total market fund, Rolf. If you mean like a world fund that invests everywhere, that wouldn't have done as well as the US over the past 10 years. But the good thing about investing in a fund like that is if it turns out that the US market is too expensive now, and that Europe and Japan, which are relatively cheaper, are better positioned, then your all-world fund will capture the upside in those markets too. They've actually been running ahead of the U.S. market year to date. There's also nothing to stop you from putting most of your stock money in a cheap index fund or two and also picking a couple of stocks on the side. These index funds have been in a race to the bottom in terms of their fees. Like, a tenth of a percent is a lot to pay for a broad market stock index fund these days. It's nothing on the scale of what you would pay for, let's say, a financial advisor or an actively managed fund. Good luck, Ralph. Who else do we have, Alexis?

Next up, we have Dhruv from Chicago, and he did not send us a voice note, so I'm going to read it for you.

Would you like to do some vocal warmups first?

It's pretty good. I love New York.

I need New York. Wait, what is this?

I love New York, I need New York, I know I need unique New York.

That's something you're supposed to say to get ready?

Yeah, it's like a diction thing from theater.

And all theater people just say about how they love New York before they do their thing?

Yeah, red leather, yellow leather, red leather, yellow leather.

How many of these do you know?

So many, I'll dedicate next podcast to them.

Okay, now that you're warmed up, what does Dhruv have for us?

He writes, I recently finished reading Safe Haven Investing, and one point stood out. The author suggests that compounding works in both directions, meaning a major market crash sets back portfolio recovery more than most experts acknowledge. It made me wonder, what's your take on how long it really takes to recover from large drawdowns? And do you think most investors and advisors underestimate that timeline?

My take is that crashes are bad, especially when you're old. And yeah, I think probably some people understate the importance of that point. If you have, I mean, the classic example is if you take an investment portfolio, if you have a 50% decline, then how much of a gain do you need to have to get back to where you were? The answer, of course, is not 50%, but 100%. It takes a long time to dig yourself out of that hole. Now, if you're young and still early in the accumulation phase of your investing, no big whoop. In fact, it's probably better for you in the long run because you can continue to buy shares of whatever you're buying at lower prices. If you're old, this is a particular problem, and it's not really your age that matters most. It's how soon you might need to spend this money. And the risk grows throughout your life, but it doesn't grow in a linear way throughout your whole life. The risk peaks at one particular moment in your life, and that's just when you've retired and you're about to begin spending this money. And financial planners call that sequence of returns risk. Suppose you've just retired and you have it all planned out for how you're going to spend this money for the rest of your life. And then you suffer a dire downturn in the stock market or wherever you're invested. And then you have less money and the prices of the things you own are lower. But now you also need to begin spending this money. In fact, because the prices are low, you have to sell more shares of whatever to fund your income in retirement. And that can hurt your chances of bouncing back, maybe permanently. This sort of thing can happen late in retirement too, but the risk isn't quite as great then just because you have less time that you have to fund with this money. Well, that sounded gloomy the way I just said that, didn't it? Hold on, let's all pause to consider our mortality. No, I don't like that at all. Where was I? Sequence of returns. The risk is lower if you have a lot of money. I mean, a lot, a lot of money, more than you're going to spend during your lifetime, so much so that mostly you're investing with your heirs in mind. The risk is greatest if you have just enough money to fund your retirement. It's one of the key reasons that folks should change to a more conservative mix of assets as they enter retirement. It's also a good reason to make sure that you're retiring at the right moment when you have enough money to support yourself, even if the market tanks right after retirement. So to sum up, Dhruv, yes, it's a humongous risk for some older folks and not much of a risk at all for most young people. That's true, I guess, of a lot of things in life. It's why I've started holding the railings when I come down my stairs in the morning. I also, just between us, go down them a little bit sideways. I got big feet and they stick out over the stairs. And, you know, I find that I get better foot placement on the stairs with a kind of a sideways approach. What I really need is an elevator or a fireman's pole, but not one of those chairlifts, Alexis. I know you're about to say it. It looks like fun, but I'm not there yet. And that's enough for this episode. I want to thank Rolf. I want to thank Dhruv. I want to thank the whole gang from Brooklyn. Vinnie Barbarino, Arnold Horschak, Freddie Boom Boom Washington, Juan Epstein. Who am I leaving out? Mr. Cotter. If you have a question you'd like played and answered on the podcast, you can send it in. It could be in a future episode. Just use a voice memo app on your phone, send it to jack.how. That's hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. If you listen on Apple, you can write us a review. Thanks and see you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar.

Where data speaks.