Matthew Bartolini takes a look at the last earnings season of 2020 and discusses the growing interest toward thematic innovative ETF strategies.
The last earnings season of a tumultuous 2020 has begun, and it is about pick up speed over the next few weeks as 40% of the S&P 500 is expected report results by the end of the month.1 Expectations are for the S&P 500 to register a -6.8% decline in earnings growth this quarter, its seventh quarter of year-over-year earnings declines in the last eight.2
However, the fourth quarter figure has been revised upward over the last few weeks up from -12.7%.3 And given that the last two quarters saw sizable upside surprises, the fourth quarter figure could end up higher than what is expected today, and perhaps positive4 – a supportive trend as we head into 2021.
Now, while the earnings trends for S&P 500 firms garner a significant amount of coverage, stocks further down the cap spectrum – and the firms associated with innovative trends not included in the glamourous MT. FAANG5 group—remain largely uncovered
Yet, as a result of the transparent nature of ETFs, this insight can be gleaned by leveraging the underlying holdings of our broad-based innovation ETF, KOMP, the SPDR® S&P Kensho New Economies ETF, and the areas of disruptive innovation it covers.
One trend heading into 2021 has been the outsized interest toward thematic innovative ETF strategies. By the end of 2020, assets in the thematic ETF category had grown organically by 171%, with over $42 billion of inflows.6 The rationale for these flows is based on the potential for higher growth from allocating to a selection of firms at the forefront of the innovation re-shaping our society. And as noted above, growth is sorely needed considering the sluggish trend even prior to the pandemic (there hasn’t been positive quarterly year-over-year growth since Q1 2019).7
This notion of potential higher growth has coincided with outsized returns, as investors seek out those potential high-growth prospects. In 2020, 67% of thematic ETF strategies outperformed the S&P 500 Index– by an average rate of 37% (56% to 18%).8 Yet, if higher growth is not being delivered, then the valuation multiples being offered may no longer be worth the price – and risk could be skewed to the downside for these firms/funds.
Innovative firms, based on the 400-plus holdings within KOMP, have illustrated their growth potential, however. The earnings profile from the three quarters of 2020 indicates this notion of higher than market growth potential. In those three quarters, growth was higher (albeit still negative given the crisis in Q1 and Q2) for innovative firms within KOMP, as shown below.
For the fourth quarter, from a high-level perspective, the estimated earnings-per-share growth for KOMP holdings is flat compared to down -6.8% for S&P 500 firms, as mentioned earlier. Additionally, as shown below, the full-year 2020, Q1 2020, and full year 2021 figures are also estimated to be higher. On a revenue basis, the holdings within KOMP are expected to post flat earnings growth, as is the S&P 500, in the fourth quarter. However, full year 2021 figures are expected to be above that of the S&P 500 – and have been upgraded over the last three months.9
However, parsing the data further shows that roughly 30% of KOMP stocks are not reporting positive earnings-per-share (EPS itself and not the growth rate) in Q4, versus 7% in the S&P 500. Some view this as an issue, given that while growth rates are high, profitability is not yet there. However, to a degree, this reflects the early-stage maturation of some of the firms – a trait synonymous with more entrepreneurial enterprises.
Removing negative EPS firms and comparing growth rates of only those firms with positive earnings (i.e., profitable firms), the rates for the median firm in Q4, 2020, Q1 2020, and 2021 are all still higher for KOMP versus the S&P 500, as shown below. The median negative EPS firms also have higher growth expected over the next two quarters10 – indicating how the firms within KOMP that are not yet profitable, or that have not been profitable over the last year, are pulling themselves out of the hole at a higher rate.
The higher levels of growth reported above have also been upgraded over the last few weeks. Since the end of September, growth for the for full year 2020 and 2021 have been increased by 7 and 5 percentage points, compared to the S&P 500’s 5 and 3.5 points, respectively. The upside revision to estimates reflects higher earnings optimism and is further reinforced by a greater number of firms having more analyst upgrades relative to downgrades in the past four weeks11 – indicating depth of optimism, not just magnitude.
While the headline growth figures are expected to be above the market, some market segments do not innovate at the same pace – an indication of why a diversified approach to harnessing the transcendent societal sea change may be more optimal than a concentrated measure of innovation. As part of the methodology for KOMP’s index, firms are classified by twenty-two areas of innovation. The chart below showcases the top five areas of innovation based on estimated growth rates for Q4 2020, Q1 2021, and full year 2021.
Wearables is the one sector to be featured across all time periods, with autonomous vehicles and virtual reality also in the top five across multiple periods. While growth is expected to be low in Q4, it is set to rebound for Advance Transport Systems in Q1 2021 and for the full year 2021. The high growth in these areas speak to the recent preference for contactless interactions in a more digital but less connected world. Overall, only three areas are expected to show a decline in Q1 2021, and no area is expected to report a decline in growth for the full year 2021.
While we are likely embarking on a period of recovery, at the same time, we must adjust to the continued evolution of corporate and consumer behaviors resulting from the pandemic. The socioeconomic paradigm has changed, and technological innovation will continue reshaping our way of life. It will touch every industry and be the catalyst for new ones.
While some of these trends (cloud storage, smart devices) existed prior to COVID-19, the pandemic has accelerated the adoption of certain behaviors by a few years — creating new future growth opportunities. These behavioral changes are not a one-off for our society, but transcendent trends that will impact future generations across a variety of different parts of our economy.
Overlooking these broad-based innovation trends may reduce a portfolio’s opportunity for growth and its potential to participate in secular change. And thematic ETFs may be a useful way to seek exposure to the evolutionary impacts that COVID-19 will continue to have on our society – one that helps investors to mitigate the stock-specific risk of getting the theme right, but the stock call wrong.
1 Bloomberg Finance L.P. as of January 15, 2021
2 FactSet based on consensus analyst estimates as of January 15, 2021
3 FactSet based on consensus analyst estimates as of January 15, 2021
4 Per FactSet as of January 15, 2021 if the past two quarter average increase is applied to the estimated earnings decline at the end of Q4 (December 31) of -9.2%, the actual earnings growth rate for the quarter would be 4.8% (-9.2% + 14.0% = 4.8%).
5 Microsoft, Tesla, Facebook, Apple, Amazon, Netflix, and Google
6 Bloomberg Finance L.P. as of December 31, 2020 per SPDR Americas Research calculations
7 FactSet as of January 15, 2021
8 Bloomberg Finance L.P. as of December 31, 2020 per SPDR Americas Research calculations
9 FactSet as of January 15, 2021 based on consensus analyst estimates. Full year 2021 estimates are expected to be 10.82% for KOMP firms and 8.24% for S&P 500 as of January 15, 2021
10 Median was used to remove the biases of large outliers as well as the S&P 500 not having a significant amount of negative earnings-per-share companies. Median KOMP holding Q4 2020 and Q1 2020 growth is -20.90% and +7.6% versus -168% and -121% for the S&P 500 negative earnings-per-share firms per FactSet as of January 15, 2021 based on SPDR Americas Research calculations
11 Out of the 240 firms within KOMP that have had any ratings changes in the last four weeks to their full year 2021 estimates, 70% of them have had more upgrades than downgrades by analysts per Bloomberg Finance L.P. data and SPDR Americas Research calculations as of January 15, 2021.
This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.
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