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 183, or 36.6% of the firms in the S&P
500 have reported (all of the numbers in this post refer to
the S&P 500). However, assuming that all the remaining
firms report exactly in like with expectations, then 50.2% 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 1.87% and the ratio is 1.81.
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.
Total net income for the 183 that have reported is 7.08% above a
year ago. That is a big improvement over the negative 3.79% a
week ago when just 70 firms had reported. It is still less
than half the 14.82% growth rate that the same 183 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 11.84%, down from 16.1%
growth in the third quarter.
The bar is also set low for the remaining 317 firms, and
significantly lower than the results we have seen so far.
They are expected to see year over year growth of just 1.93%.
If we exclude the Financial sector, earnings are expected to be
2.02% below last year's. That is far below the 15.99% total
and 19.16% ex Financial growth those 317 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 183 reporting 6.05%
growth. Most of the revenue weakness though has come from the
financials. If we exclude the Financials that have reported,
revenue is up 9.05% year over year.
The 317 are expected to see revenue growth to slow to 3.08% in
total and 7.56% excluding the Financials. In the third
quarter, the 317 reported revenue growth of 13.16% in total and
14.18% 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 183, net margins
have come in at 11.32%, up from 11.21% a year ago, but down from
11.82% in the third quarter.
For the 317, margins are expected to be much lower, but they are
lower margin businesses to begin with. They however are also
expected to fall, dropping to 7.42% from 7.51% last year, and well
below the 7.78% in the third quarter. Excluding Financials
the picture is even worse, with net margins of just 6.90% expected,
down from 7.57% a year ago and 7.96% 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
On an annual basis, 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
9.04% in 2011 and 9.26% in 2012. The pattern is a bit
different, particularly during the recession, 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 8.67% in 2011. However, they are
expected to drop to and 8.62% in 2012.
Total net income in 2010 rose to $789.0 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 $894.6 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 $983.0 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, 6.01%
The "EPS" for the S&P 500 is expected to be over the $100
"per share" level for the first time at $103.73 in
2012. That is up from $56.83 for 2009, $83.23 for 2010,
and $94.38 for 2011. In an environment where the 10 year
T-note is yielding 1.90%, a P/E of 15.8x based on 2010 and 14.0x
based on 2011 earnings looks attractive. The P/E based on
2012 earnings is just
Estimate revisions activity is past its seasonal low, and rising
very fast. 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
The revisions ratio for FY1, which is mostly 2011 earnings now
stands at 0.50, or two cuts for every increase. The cuts are
very widespread, with only a single sector, Transports, seeing more
increases than cuts. Eight of the sectors, including big ones
like Energy, Health Care, 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 0.61. Only three sectors,
Transports, Construction and Business Service 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 0.52 and 0.59, respectively.
Relative to recent quarters, we are off to an exceptionally weak
start, but we are still seeing more positive than negative
surprises. We did get some very big and significant positive
surprises in the last week, most notably Apple (
) and Caterpillar (
). As the earnings season has progressed, things have been
getting a bit better, but only moved the season from being very
poor, to Mediocre at best.
This is happening when the bar is set at its lowest point in a
very long time. For the remaining firms, the bar is also set
low, however given the results so far, that really does not provide
any assurance that they will be able to clear it. The market
has been off to a very strong start of the year, despite the weak
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 99 S&P 500 firms
scheduled to report. Thus by next week, we will be well past
the halfway point in terms of the number of reports. We are
already past it based on the total earnings for the
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