ByPatrick J. O'Hare:
The third-quarter earnings results were better than expected.
That doesn't mean, however, that they were good. Furthermore,
guidance for the fourth quarter left a lot to be desired.
One Good Exclusion Deserves Another
According to FactSet, the third-quarter blended earnings growth
rate was -3.1% on September 30. Today it is -0.9%.
That is the basis for saying the reporting period was better
than expected. However, the 0.9% decline in earnings, along with
the understanding that third-quarter revenue declined 1.2%, is the
basis for saying the results in aggregate were not good.
Much of the blame for the earnings decline can be placed on the
Energy sector, which experienced a 17.7% decline in third-quarter
earnings. If it is excluded, FactSet notes the growth rate for the
third quarter would improve to 2.3%.
Conversely, the Financials sector, which enjoyed 11.8% growth,
is the main reason why the third-quarter blended growth rate wasn't
worse. If the Financials sector is excluded, the growth rate for
the third quarter would fall to -3.2%.
Exclusions notwithstanding, it all counts in the end.
An earnings and revenue growth summary for each sector is
provided in the table below.
|
Sector
|
Q3 Earnings Growth
|
Q3 Revenue Growth
|
|
Consumer Discretionary
|
3.8%
|
2.8%
|
|
Consumer Staples
|
1.3%
|
1.2%
|
|
Energy
|
-17.7%
|
-17.1%
|
|
Financials
|
11.8%
|
2.6%
|
|
Health Care
|
-0.7%
|
5.2%
|
|
Industrials
|
4.0%
|
1.1%
|
|
Information Technology
|
1.2%
|
3.2%
|
|
Materials
|
-23.6%
|
-6.4%
|
|
Telecom Services
|
0.8%
|
2.8%
|
|
Utilities
|
-1.7%
|
0.1%
|
|
S&P 500
|
-0.9%
|
-1.2%
|
Source: FactSet
Lowering the Bar
In terms of negative surprises, they were concentrated on the
top-line and in the earnings guidance for the fourth quarter.
Just 41% of S&P 500 companies reporting revenue exceeded
expectations. According to FactSet, that is the lowest percentage
of companies surpassing expectations since the first quarter of
2009.
The lackluster revenue growth is perhaps the most
underappreciated aspect of the third-quarter reporting period. It
shows that demand is weak and it indicates that earnings growth
will be hard to come by if companies can't expand profit margins
that are already near record high levels.
Plenty of companies sounded an earnings warning, too. Out of the
103 companies issuing fourth-quarter guidance, 73% issued negative
EPS guidance. That is well above the long-term average of 61%.
The disproportionate number of warnings prompted analysts to
lower their forward-looking estimates.
According to FactSet, fourth-quarter earnings growth is now
projected to be 3.9% versus 9.3% at the end of September. The
earnings growth estimate for the first quarter has been cut to 3.1%
from 5.3%.
The downward revision to growth estimates is not a surprise to
us. We said in our earnings preview October 8, that we expected
growth estimates to come down given the weak macroeconomic
conditions and the uncertainty regarding the presidential election
and the fiscal cliff.
|
Sector
|
Q4 Earnings Growth
|
Q4 Revenue Growth
|
|
Consumer Discretionary
|
5.8%
|
4.7%
|
|
Consumer Staples
|
3.2%
|
2.7%
|
|
Energy
|
3.5%
|
-8.2%
|
|
Financials
|
21.6%
|
7.0%
|
|
Health Care
|
-0.9%
|
6.8%
|
|
Industrials
|
-4.3%
|
1.3%
|
|
Information Technology
|
-2.3%
|
5.5%
|
|
Materials
|
6.5%
|
-0.7%
|
|
Telecom Services
|
14.1%
|
1.7%
|
|
Utilities
|
6.6%
|
11.3%
|
|
S&P 500
|
3.9%
|
2.5%
|
Source: FactSet
2013 Earnings Glass Still Half Full
The election uncertainty is over, but the fiscal cliff
uncertainty is as high as ever. That uncertainty coupled with the
stronger dollar, Europe's problems, and the slowdown in emerging
markets were oft-cited explanations for disappointing guidance.
The earnings growth estimate for calendar year 2013, however,
hasn't changed much. It stood at 11% at the end of September. Today
it is 10%.
With projections for just 3% earnings growth in the first
quarter, analysts are clearly expecting things to ramp up as 2013
unfolds.
Something else is also apparent in the table below. Considering
earnings growth is expected to outpace revenue growth in every
sector except the Utilities sector, analysts must be expecting
strong profit margin expansion and/or strong share buyback activity
in 2013.
|
Sector
|
CY13 Earnings Growth
|
CY13 Revenue Growth
|
|
Consumer Discretionary
|
13.6%
|
5.5%
|
|
Consumer Staples
|
8.9%
|
4.6%
|
|
Energy
|
4.9%
|
-2.8%
|
|
Financials
|
14.1%
|
3.3%
|
|
Health Care
|
6.8%
|
4.4%
|
|
Industrials
|
9.0%
|
4.4%
|
|
Information Technology
|
9.1%
|
6.8%
|
|
Materials
|
20.7%
|
4.9%
|
|
Telecom Services
|
20.6%
|
1.8%
|
|
Utilities
|
1.8%
|
5.3%
|
|
S&P 500
|
9.9%
|
3.5%
|
Source: FactSet
At this point, we would argue that earnings growth estimates for
CY13 are overly-optimistic given the ongoing struggles in Japan and
the eurozone, and the drag that the fiscal cliff -- compromise or
not -- will have on the U.S. economy.
Our economic outlook calls for muted growth in the first half of
2013 and a return toward a weak 2.0% growth rate in the back half
of the year.
What It All Means
The third-quarter earnings reporting period came and went,
largely overshadowed by the intrigue surrounding the presidential
election and the fiscal cliff.
The earnings results themselves ended up being better than
expected, yet that isn't saying much when better than expected
equates to no growth.
Although estimates for the fourth quarter have been chopped down
from silly heights, the double-digit growth estimate for calendar
year 2013 is expecting too much. The eurozone and Japanese
economies will be barely growing, if they are growing at all, and
the U.S. economy will be fortunate to grow 2.5% even with a
compromise on the fiscal cliff.
While there might be a relief rally on word of a fiscal cliff
compromise, bear in mind that any compromise will be a drag on
economic growth and that the revision risk for earnings growth will
remain to the downside.
Those are risk factors that should not be forgotten by investors
when headline hoopla prompts the market to take leave of its
fundamental senses.
More directly, they are risk factors that support a
defensive-minded approach to investing in the equity market.
Double-digit earnings growth expectations just don't mesh with
the weak growth outlook for most of the world's largest
economies.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
Weed Stock Spotlight: AVT, Inc.
on seekingalpha.com