The week of February 6^th marked a notable event for the Russell 1000 where the 1-year percent change in the forward 12-month EPS estimate turned negative. In the last 20 years, this has only occurred on three prior occasions – July 2008, August 2015, and March 2020.

Using Refinitiv Datastream, the forward 12-month EPS estimate for the Russell 1000 is currently $236.81 per share compared to $238.18 last year, resulting in a 1-year percent change of -0.6% (Exhibit 1).

It is very likely that we continue to see a further decline in this calculation as we progress throughout the year for two reasons: 1) base effects (F12m estimates were rising throughout the first half of 2022), and 2) if analysts continue to downgrade current year and next year EPS estimates.

Exhibit 1: 1y % Change in F12m EPS

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The forward 12-month EPS is a time-weighted average between FY1 (2023) and FY2 (2024). Given where we are in the current calendar, most of the weight in this calculation will be placed on FY1 and therefore we take a closer look at 2023 estimates below.

Exhibit 2 shows a ‘worm’ chart for the Russell 1000.A worm chart displays a time-series EPS for each line (worm) on the graph. For example, the blue line displays the 2023 EPS estimate for the Russell 1000 since Refinitiv I/B/E/S began collecting data for this particular year.

Looking at the 2023 ‘worm’, analysts have gone in a full circle as the starting EPS estimate was $228.72 on February 2021, reached a peak of $264.11 on April 2022, and has since come down to $230.81 today (-12.6% from its peak).

Exhibit 2: Russell 1000 Annual EPS estimates

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Exhibit 2 also shows an interesting pattern into analyst behaviour. Looking at every individual ‘worm’, we see that the starting point for each line is typically higher than the finishing point. In other words, analysts typically start with overly optimistic estimates and eventually downgrade as we head into the actual earnings year (see the bottom-left of the chart which shows EPS data for 2014-2017).

During the height of the pandemic, we saw aggressive downgrades in EPS estimates during March-June 2020 as shown in the 2020 (pink), 2021 (orange), and 2022 (black) worm. Once the bad news was priced into the market, analysts began to revise estimates upwards starting in July 2020 through April 2022, after which analysts began to downgrade in the face of peak-inflation and central banks raising interest rates.

Exhibit 3 highlights how 2023 EPS estimates have been revised since the start of 2022. We also include the Russell 2000 (U.S small-cap index) to better gauge analyst expectations between large-cap and small-cap companies.

Exhibit 3: Russell 1000 and 2000 EPS Estimate Revision

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Analysts appear more pessimistic around small-cap companies compared to large-caps, as the Russell 2000 has seen its 2023 EPS estimate revised downwards by 25.1% since 2022 vs. a -9.4% decline for the Russell 1000.

This divergence may be due to the current macro environment, where large-cap companies enjoy stronger pricing power, higher margins, and a stronger balance sheet compared to its small-cap counterparts, resulting in conditions that are advantageous in face of a higher rate and lower growth environment.

There is a stark difference in net profit margins for large-cap vs. small-cap companies, as the forward 12-month net profit margin for the Russell 1000 is 11.6% vs. a 4.8% margin for the Russell 2000.

Growth vs. Value?

We finish off by looking at the Russell 1000 and 2000, except we also look at the ‘Growth’ and ‘Value’ index to assess analyst sentiment by factors.

Exhibit 4 shows the same data as Exhibit 3, but we also include EPS revisions for the Growth and Value index. The Russell 1000 Growth index has seen its EPS estimate revise downwards by 12.3%, while the Value index has seen its estimate decline by only 6.4%.

This makes intuitive sense with a backdrop of higher rates for longer which hurts the valuation for long-duration growth stocks compared to value stocks.

Having said this, we observe a noticeable difference within the Russell 2000, where the Value index has experienced a downward revision of 28.2% – far greater than the Russell 2000 Growth index which has seen a negative revision of only 16.5%.

Exhibit 4: Russell 1000 & 2000 Growth and Value EPS Revision

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From a valuation perspective, the Russell 1000 Index has a forward P/E of 18.4x, while the Russell 1000 Growth index trades at 23.4x in comparison to 15.3x for the Russell 1000 Value index.

Both the Russell 1000 and Russell 1000 Growth index trade at a forward P/E multiple above its respective 10-year average, while the Russell 1000 Value index is matching its 10-year average.

In comparison, the Russell 2000 Index has a forward P/E of 23.4x, while the Russell 2000 Growth index trades at 30.1x in comparison to 19.1x for the Russell 2000 Value index.

Conclusion

It is rare to see a 1-year percent change in the forward 12-month EPS estimate to turn negative (has occurred four times in 20 years) which highlights the dramatic deterioration in analyst expectations. As we are roughly half-way through the 22Q4 earnings season, we have seen many companies issuing lower guidance for 2023, which will likely put further pressure on both current and next-year estimates.

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