With the third quarter winding down, investors are looking ahead to the upcoming third quarter earnings season, which begins in earnest around October 11, when big banks like JPMorgan Chase (NYSE:JPM) release earnings.
Stocks enjoyed a successful second quarter, overall, as the combined earnings per share for the S&P 500 was up 12.9% for the quarter, according to Standard & Poor’s Global. Of the 11 sectors, nine of them had higher year-over-year earnings, led by communication services, up 27.6%, information technology, up 20.5%, healthcare, up 18.4%, and financials, up 17%. Only the industrials (-2.6%), materials (-7.5%), and real estate (-10.9%) sectors were down.
Q2 was the fourth straight quarter with overall earnings growth and the highest year-over-year earnings growth rate since the fourth quarter of 2021.
What’s in store for Q3? Analysts predict earnings growth in the quarter, but not to the level we saw in Q2. Here are four things to expect in Q3.
1. Earnings to grow for fifth straight quarter
According to financial data provider FactSet, earnings per share growth in the S&P 500 is projected to be 4.6% in Q3. That’s down from Q2 and lower than the 7.8% growth rate that was projected at the start of Q3. It is also below the five-year average earnings growth rate of 10% and the 10-year growth rate of 8.5%. Nonetheless, it is still the fifth straight quarter of earnings growth.
About 60 of the 110 S&P 500 companies that issued third quarter guidance issued negative EPS guidance, while 50 issued positive Q3 EPS guidance. The 55% that issued negative guidance is slightly below the five-year average of 58% and the 10-year average of 62%.
Further, the S&P 500 is expected to report 4.7% year-over-year revenue growth in the quarter, down from initial revenue growth projections of 4.9% on June 30. This would be the 16th consecutive quarter of revenue growth for the S&P 500.
2. Energy and industrials down; IT, communications, and healthcare up
Of the 11 sectors, eight of them are expected to report positive earnings in Q3, while three of them will show negative earnings.
The fastest growing sector in the quarter, according to FactSet, is information technology, estimated to be up 15.3% year over year in Q3. Within this sector, semiconductor earnings are projected to rise 37%, leading the way, followed by technology hardware, up 13%.
In terms of individual companies, NVIDIA (NASDAQ:NVDA) is expected to be the largest contributor to earnings growth for the sector in Q3. In fact, if NVIDIA was excluded, the estimated earnings growth rate for the IT sector would fall to 7.9%, from 15.3%.
The healthcare sector is projected to grow earnings by 11% in Q3, led by pharmaceuticals, up 32%. Pfizer (NYSE:PFE), Eli Lilly (NYSE:LLY), and Moderna (NASDAQ:MRNA) are anticipated to be the top contributors.
Also, the communication services sector expected to see 10.5% earnings growth in the quarter, led by strong growth from Alphabet (NASDAQ:GOOGL) and Meta Platforms (NASDAQ:META).
On the downside, energy is expected to see earnings decline by 17.6% in the quarter, hurt by a drop in oil prices. Industrials will see a 7.7% earnings decline, according to FactSet data.
3. Valuations are still above average
The forward price-to-earnings (P/E) ratio for the S&P 500 for the third quarter is roughly 21.4, which is higher than the 5-year average of 19.5 and the 10-year average of 18.0, according to FactSet. Further, it is slightly higher than it was at the end of the second quarter, when it stood at 21.0.
Also, since June 30, the price of the of the S&P 500 increased 4.6%, while the forward EPS estimate climbed only 2.8%.
The IT sector, with a forward P/E of 28.8, is still the priciest and it is well above its five-year average P/E of 24.7 and its 10-year average of 20.9. Consumer discretionary is next with a 25.4 forward P/E, followed by industrials at 22.1 and consumer staples at 21.4.
If you are looking for deals, the cheapest sectors are energy with a 12.6 forward P/E, followed by financials at 16.1, utilities at 18.2, and communication services at 18.7.
4. Where the best buys are
Given its relatively low valuation with a forward P/E of 18.7, Wall Street analysts are most bullish on communication services. The communication services sector has the highest percentage of “buy” ratings at 64%, followed by energy at 62%, and IT at 61%.
Analysts are less optimistic about the consumer staples, utilities, and materials sectors, which have the lowest percentages of buy ratings at 43%, 48%, and 49%, according to FactSet.
Finally, while growth will be muted in Q3, it is expected to accelerate in Q4 and beyond. Analysts anticipate 15% earnings growth in Q4, followed by 14.6% in Q1 2025 and 13.7% in Q2 2025.
Further, S&P 500 earnings growth is expected to be 10% for calendar year 2024 and 15.2% for 2025.