Now that Wall Street is about to close the books on yet another earnings season, it’s time to see which names posted higher-quality earnings than others, according to UBS. Investors parsing through fourth-quarter results have been searching for clues into how companies have been navigating this period of higher inflation and rising interest rates. In the S & P 500, about 86% of companies reported quarterly earnings thus far, according to FactSet data. And, of those firms, about 69% have posted positive surprises. However, UBS’ strategist Keith Parker worries that earnings quality is an “overhang,” saying the divide between earnings and operating cash flow for companies points to roughly 15% earnings-per-share downside for at-risk stocks. “Earnings have typically moved closely with operating cash flow (OCF), but earnings have risen by much more than OCF the last year outside of [financials/energy] as firms have accrued less on the expense side and working capital has risen. Reconnecting with OCF, an arguably more reliable measure of profitability, would point to EPS downside of ~15% for S & P ex Fins/Ener,” Parker wrote in a note this month. “With the median accrual (earnings-OCF dif) at an all time high pointing to broad EPS risk, the high vs low accrual spread is also near the wides making accruals a critical factor to identify relative earnings risk or resilience for stocks,” Parker added. Given this, the strategist identified stocks that have derisked earnings. These stocks are in the S & P 1500, have a market cap greater than $3 billion, excluding stocks in financial, real estate and utilities. Additionally, they have lower accruals, or better operating cash flow than earnings, and have a greater decline in forward price-to-earnings, according to the note. They also have stronger 3-month earnings revisions. Here are the names. Google-parent Alphabet posted higher-quality earnings. Recent layoffs, as well as other cost-cutting measures, bolstered investor confidence in the stock. UBS’ analyst Lloyd Walmsley said disciplined spending “should lead to margin stability” though he warned that rising competition “could lead to reinvestment.” Darden Restaurants made the list. The parent company behind Olive Garden and LongHorn Steakhouse demonstrated “above avg resiliency” in previous recessions, and should “continue to manage macro pressures well,” according to UBS analyst John Hodulik. Meanwhile, Humana demonstrated strong earnings quality because of its leading position in the Medicare Advantage market, according to UBS analyst Kevin Caliendo. He wrote, “The strong earnings quality is forecasted to drive FCF north of $5B in 2023, with the FCF-earnings delta being driven by benefits payable moving higher, reflecting reserve strengthening.” Other stocks listed are Las Vegas Sands and Chipotle Mexican Grill .
