The 2014 Q4 earnings season takes center stage next week with Alcoa’s (AA - Analyst Report) release after the close on Monday. Alcoa isn’t the overall first to report Q4 results, though it is the first S&P 500 member with a fiscal calendar quarter to come out with results. Companies with fiscal quarters ending in November have been reporting since mid-December, with 17 such S&P 500 members having reported results already.

In fairness to Alcoa, however, the market starts paying attention to the earnings season after their earnings announcement even though the list of companies that report before it includes such industry leaders like FedEx (FDX - Analyst Report), Nike (NKE - Analyst Report) and others. In total, we will see results from 4 S&P 500 members the rest of this week, with 20 index members on deck to report results next week.

Here are the four key points to know about this earnings season.

First, estimates remain low, having fallen sharply over the last three months. Total earnings for the quarter are expected to be up +1.2% on -0.5% lower revenues and modestly higher margins.

Second, the magnitude of negative revisions that Q4 estimates went through over the last three months was the highest that we have seen in almost two years. The current +1.2% total earnings growth expected in the quarter is down from +9.6% at the start of the quarter.

Third, the outsized decline in Q4 earnings estimates isn’t a reflection of a fresh deterioration in overall corporate profitability, but rather a function of the unusual oil price action in the recent past. By our estimates, roughly 45% of the drop in aggregate Q4 bottom-up total earnings since the start of the quarter is accounted for negative Energy sector revisions.

Fourth, low expectations mean an easy-to-beat hurdle rate for management teams. Nothing unusual there as management teams have refined the art of expectations management, with more than two thirds of the S&P 500 members coming ahead of consensus earnings estimates. But more than actual Q4 growth rates and beat ratios, we will be looking for management commentary about business conditions in the current backdrop of global growth worries. Guidance has overwhelmingly been negative in recent quarters and we will likely see more of the same this time around as well. But it will be interesting to see if the tone of management commentary any change, favorable or otherwise, in the outlook.  

The Ever Falling Estimates

Estimates for 2014 Q4 started coming down at an accelerated pace as companies predominantly guided lower on the 2013 Q3 earnings calls, consistent with the trend we have been seeing for almost two years now. Total Q4 earnings for companies in the S&P 500 are currently expected to be up +1.2% from the same period last year, a material decline from the +9.6% growth expected at the start of the quarter in early October. The table below presents the summary picture for Q4 contrasted with what companies actually reported in the Q3 earnings season.

The chart below shows how estimates for Q4 have evolved since the quarter got underway. Please note that the magnitude of negative revisions for Q4 is the highest we have seen at comparable periods in other recent quarters, with the Energy sector as the biggest drag.

The negative revision trend is widespread, but is particularly notable for the, Basic Materials, Energy, Autos, Industrial Products, and Retail sectors. Construction, Utilities, and Business Services were the only sectors where estimates have modestly gone up.

The chart below shows the sectors with big negative revisions.

The negative revisions trend has been widespread, with 13 of the 16 Zacks sector suffering negative revisions over the last three months. That said, the revisions trend in the Energy sector stands out, with estimates for the quarter dropping from positive growth of +7% at the start of the quarter to a decline of -20% at present. This massive shift becomes evident when you look at what has been happening to estimates for some of the sector leaders like Exxon (XOM - Analyst Report), Chevron (CVX - Analyst Report) and ConocoPhillips (COP - Analyst Report). The Zacks Consensus EPS estimates for Exxon, Chevron, and ConocoPhillips dropped -22.5%, -33.2% and -44.7%, respectively over the last three months. Please note that these three companies combined bring in roughly 45% of the sector’s total earnings

With roughly two-thirds of S&P 500 companies beating earnings expectations in any reporting cycle, actual Q4 results will almost certainly be better than these pre-season expectations. In fact, a look at the revisions trend for the last 5 quarters show that the actual growth rate at the end of the reporting cycle roughly approximates what was originally expected at the start of the quarter. You can see this trend play out clearly in the chart below

What this means is that at the growth rate at the start of the (calendar) quarter is a good representation of what is actually achieved in that period. For example, earnings were expected to be up +6.3% in Q3 at the start of the quarter in July. But those growth estimates came down over time and fell to +3% by the time the Q3 reporting season got underway. The actual growth in Q3, however, turned out to be +6.2%.

Will we see a repeat performance in Q4 as well? We will have to wait through the end of February to find out.

Note: For a complete analysis of 2014 Q4 estimates, please check out weekly Earnings Trends report.

Here is a list of the 37 companies reporting this week, including 4 S&P 500 members.