Third quarter earnings season was a good one, unfortunately we
may not be able to say the same about the fourth quarter. We
got off to a very weak start, and while the last week was better,
it just pushed the season from being very poor to mediocre at
best. So far 290, or 56.0% of the firms have reported.
However, assuming that all the remaining firms report exactly in
like with expectations, then 72.8% of all earnings are in.
Normally, when all is said and done, the median surprise runs about
3.00% and the ratio about 3.0. So far, the median is at 1.92%
and the ratio is 1.93. Both up from last week, but still well
below normal. While we don't have the drama of multi billion
dollar bank losses, this is the weakest start to an earnings season
since the depths of the Great Recession.
In most recent quarters, we have started out of the gate much
faster than that only to fade towards those levels, this time the
reverse is try, but we are running out of real estate to catch
up. Total net income for the 290 that have reported is 5.59%
above a year ago. It is still less than a third the 18.25%
growth rate that the same 290 firms reported in the third quarter.
The picture is just a little bit better if we take the Financials
out of the picture. Without them, the year over year
rise in net income is 7.76%, down from 20.37% growth in the third
quarter. Sequentially, total net income so far is 7.01% below
the third quarter, or 4.95% lower ex financials. Last year
the sequential growth was 4.14%, and 6.17% ex financials. In
other words the pressure on the growth rate is coming from both the
numerator and the denominator.
The bar is also set low for the remaining 210 firms, and
significantly lower than the results we have seen so far.
They are expected to see year over year growth of just 1.74%.
If we exclude the Financial sector, earnings are expected to be
3.76% below last year's. That is far below the 5.90% total
and 11.31% ex Financial growth those 210 reported in the third
quarter. In other words, we have started out weak, and it is
expected to get worse.
Revenue growth has held up better, with the 290 reporting 7.59%
growth. Most of the revenue weakness though has come from the
financials. If we exclude the Financials that have reported,
revenue is up 9.67% year over year. The 210 are expected to
see revenue growth to slow to negative 0.94% in total and positive
6.06% excluding the Financials. In the third quarter, the 210
reported revenue growth of 9.24% in total and 10.23% excluding the
financials. With revenue growth slowing, but holding up
better than net income growth, it means that the net margin
expansion game is coming to an end. It has been a very big
part of the spectacular earnings growth that we have seen coming
out of the Great Recession.
For the 290, net margins have come in at 9.84%, down from 10.03%
a year ago, and down from 10.69% in the third quarter. For
the 210, margins are expected to be much lower, but they are lower
margin businesses to begin with. They however are expected to
rise to 7.21% from 7.02% last year, and up from the 6.82% in the
third quarter. That is entirely due to the remaining Financials.
Excluding Financials net margins of just 6.52% expected, down from
7.18% a year ago and 7.13% in the third quarter. While in an
absolute sense, those are still very healthy net margins, much
higher than the average of the last 50 years or so, but they are no
longer expanding. Then again, it was unrealistic to expect
that they would always rise. It does mean that earnings
growth is going to be harder to come by going forward.
On an annual basis (all 500), net margins continue to march
northward, but we are beginning to see cracks there as well.
In 2008, overall net margins were just 5.88%, rising to 6.27% in
2009. They hit 8.51% in 2010 and are expected to continue
climbing to 9.00% in 2011 and 9.24% in 2012. The pattern is a
bit different if the Financials are excluded, as margins fell from
7.78% in 2008 to 6.93% in 2009, but have started a robust recovery
and rose to 8.12% in 2010. They are expected to rise to 8.63%
in 2011. However, they are expected to drop to and 8.60% in
2012.
Total net income in 2010 rose to $788.8 billion in 2010, up from
$538.6 billion in 2009. The expectations for the full year
are very healthy. In 2011, the total net income for the
S&P 500 should be $893.5 billion, or increases of 46.5% and
13.4%, respectively. The expectation is for 2012 to have
total net income come close to $1 Trillion mark to $988.0 Billion,
for growth of 10.1%. Consider those earnings relative to
nominal GDP. If we use the middle of the year GDP level,
S&P 500 net income has climbed from 3.89% in 2009 to 5.45% in
2010, and assuming that the 2011 expectations are on target, 6.00%
in 2011.
Of course, the S&P 500 earns a lot of its income abroad
(apx. 40%), and there are a lot more than 500 companies in the U.S.
so to some extent that is an apples to oranges comparison. It
is somewhat ironic that the growth in earnings was robust when the
economy was anemic, but now that the economy seems to be picking
up, earnings growth is slowing down dramatically. Europe
however is falling back into recession, and even if the Euro does
not totally fall apart, it is likely to be a deep and nasty
one. The BRIC's have also all shown signs of slower, but
still robust by developed country standards, growth. In their
conference call commentary, many companies are blaming the slowdown
in earnings growth on Europe, which represents about 15% of S&P
500 earnings.
The "EPS" for the S&P 500 is expected to be over the $100
"per share" level for the first time at $104.05 in
2012. That is up from $56.79 for 2009, $83.21 for 2010,
and $94.21 for 2011. In an environment where the 10 year
T-note is yielding 1.83%, a P/E of 15.93x based on 2010 and 14.07x
based on 2011 earnings looks attractive. The P/E based on
2012 earnings is just 12.72x. The P/E's and T-note rates are
as of Thursday (to keep it consistent with the earnings data) but
on Friday the stock market was strong and the bond market was weak
in response to the employment
report.
Estimate revisions activity is rising fast, and approaching a
seasonal peak. In previous earnings seasons we have
generally seen a bounce in the revisions ratio, as the analysts
have reacted to better than expected earnings and the outlooks on
the conference calls. So far there is no evidence of that
happening. The revisions ratio for FY1, which is mostly 2011
earnings now stands at 0.57, or almost two cuts for every
increase. The cuts are very widespread, with only three
sectors seeing more increases than cuts. Eight of the
sectors, including big ones like Energy, Health Care, Staples and
Utilities are seeing more than twice as many cuts as
increases. The picture for FY2, or mostly 2012 is only
slightly better, with a revisions ratio of just 0.64. Only three
sectors are seeing more increases than cuts. The widespread
cuts are also confirmed by the ratio of firms with rising mean
estimates to falling mean estimates, which now stand at 0.56 and
0.61, respectively. .
As the earnings season has progressed, things have been getting
a bit better, but only moved the season from being very poor, to
mediocre. This is happening when the bar is set at its
lowest point in a very long time. For the remaining firms,
the bar is set even lower. The market has been off to a very
strong start of the year, despite the weak early results.
Valuations are still compelling, if somewhat less so than a few
months ago. However, if the results do not improve, it
strikes me as likely that we will at least pause for a while.
The upcoming week will be a busy one, with 69 S&P 500 firms
scheduled to report.
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