Q3 Earnings Still Driven by Mag 7

Mag 7 leads the way for Q3 earnings… again

Q3 earnings season is (unofficially) over, with the last of the Mag 7 companies, Nvidia, reporting yesterday (earnings rose +100% YoY). And it’s déjà vu all over again.

As we’ve seen for much of the last two years, large cap earnings growth was (mostly) driven by the Mag 7, while earnings shrunk for mid caps and small caps.

In Q3 (orange box), Mag 7 earnings grew +20% YoY (lighter blue bars), while the rest of the S&P 500’s earnings grew just +3% (orange bars). Combined, S&P 500 earnings increased +5.8%.

Any gain would have bested the S&P 400 mid caps (navy blue bars) and S&P 600 small caps (green bars) – both of which saw their earnings shrink… again. In fact, mid-cap earnings growth has been negative for 7 of the last 8 quarters, and it’s 9 quarters in a row for small caps.

Mag 7 margins have increased to 24% from 17% since early 2023

If you want to understand why the Mag 7 is outperforming those other groups of stocks, look at their margins.

Since early last year, Mag 7 margins have increased from 17% to 24% (chart below, lighter blue line) – making their margins fully double the rest of the S&P 500’s (orange line)!

While Mag 7 margins have been rising, margins for the rest of the S&P 500 and mid caps (navy blue line) have held steady just below their 2022 highs.

For small caps, though, their margins have shrunk to 6% from 7.5% (green line). As we’ve shown before, small caps have faced more margin pressure from higher Fed rates since they have more floating rate debt.

YTD returns mostly driven by earnings for Large Caps, multiple expansion for mid and small caps

This strong margin expansion and earnings growth help explain why the Mag 7 have seen a second straight year of big price gains.

In fact, three-quarters of the Mag 7’s +40% price gains this year (chart below, left most orange circle) is attributable to earnings growth (green portion of bar). The rest of the S&P 500 can attribute a similar share of their +16% return this year to earnings growth.

Somewhat surprisingly, mid caps have seen a better returns (+18%), despite weaker earnings growth. In fact, for mid caps and small caps, the bulk (or all, for small caps) of their gains this year are driven by multiple expansion (blue portion of bars) – meaning more by improved expectations than actual earnings.

To keep these gains, those expectations will have to be met at some point.

For mid caps, it might not be in Q4 earnings season, where earnings are expected to contract again (first chart, grey box). But it could be next year, with analysts projecting +13% YoY earnings growth for mid caps and +18% growth for small caps. Then we might have something other than the Mag 7 to talk about during earnings.

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