Q4 earnings season in Europe has given investors something to cheer about. 75% of companies have reported to date, and the Q4 Earnings Per Share (EPS) are up 12.1% Y/Y. This is the strongest number since Q4 2013, with 7 out of 10 sectors running ahead of consensus expectations. Outlooks for 2017 seem to be improving, with guidance from management quite positive. Earnings growth forecasts for the Stoxx 600 now stand at c.15%. Optimism prevails. However, if history is anything to go by, these forecasts may be too enthusiastic. For many, annual EPS forecasts can be more a case of fantasy, as we have seen in the past 6 years, in which expectations have been downgraded, as we moved through the year. Will 2017 be different? We do believe this year will be different, but also see current expectations as probably being too full. Our house view is that the Eurozone will experience +8.4% EPS growth, while Pan-European markets will be a little higher at +9.5%.
Enough Fantasy, Lets Focus on Reality
For the more sceptical amongst us, it is worthwhile to look at the realised earnings instead of forecasts. For European corporates, trailing earnings have just turned positive in the first week of February. This has not been driven by just a few outlying sectors, but rather we have seen some robust growth across both cyclical and non-cyclical areas of the market.
For a Clear Sign, Look at the Top Line
Perhaps the most encouraging take away from the recent results season is the delivery of top line growth. Earnings momentum from European companies in recent quarters has been driven by margin expansion, predominantly from cost cutting, rather than by revenue growth. This dynamic is unsustainable, so it is refreshing to see top line momentum coming through, suggesting earnings are forming a more maintainable foundation. A more positive operating environment is appearing and Europe may be better placed on a relative basis in 2017.
A Final Word of Wisdom
Without doubt, the outlook is brighter, and the delivery of earnings growth is a welcome tailwind. That said, it is needed, as valuations are fuller and the market requires earnings to go higher. Looking at the recent results, the dispersion in share price reactions on the day of release is at an all-time high. Investors are rewarding the companies that are delivering and punishing those that are not. This environment of higher dispersion and fuller valuations, which should encourage investors to focus on stock selection.