Submitted by
Wall St.
Daily
as part of our
contributors program
.
On Monday, I
debunked the age-old practice
of treating aluminum giant,
Alcoa's
(
AA
), earnings as a leading indicator for the rest of corporate
America.
It's just not reliable.
A handful of pundits agree with me. Yet they go a step further
and contend that
JP Morgan Chase
(
JPM
) should assume Alcoa's place of prominence. Try again!
While JP Morgan has a broader reach into our economy, it's still
just one company. And reading too much into a single company's
report is asking for trouble.
There's just no way that doing so can accurately predict the
outcome for thousands of other companies. Period.
Accordingly, I don't recommend wasting any more time hunting for
such a "Holy Grail" stock. Instead, we should focus on three key
metrics that
really
matter this reporting season.
But before I get to them, let me provide a little context…
Expectations: From Bad to Worse… and Still
Irrelevant
No doubt about it: This earnings reporting season, which kicks
into high gear next week when 732 companies are scheduled to
report, promises to be one of the ugliest in recent memory.
On a whole, S&P 500 companies are expected to report a 2.6%
drop in profits. If actual results match that projection, it would
end the growth streak we've seen the past 11 quarters in a row.
For months now, analysts and companies alike have been preparing
us for this inevitability, as well. I wouldn't read too much into
the negativity, though.
As Dan Greenhaus, Chief Global Strategist at BTIG, says,
"Earnings guidance is a game that everybody plays and nobody
acknowledges."
In other words, companies' overly downbeat projections could be
setting the stage for a classic relief rally, as actual results
(surprise) come in ahead of expectations.
Even if corporate profits
do
fall this quarter, though, we need to put them into
perspective.
After all, the S&P 500 is still on pace for its
third-highest earnings-per-share payout in history of $25. The
second-highest total came in the third quarter of 2011, which makes
year-over-year comparisons for this quarter tough. We'd basically
need to hit an all-time high in profitability, which just isn't
reasonable to expect.
So instead of obsessing about the year-over-year earnings growth
rate, we should be focusing on these three metrics.
~ Key Statistic #1: Earnings "Beat Rate"
As long as companies are producing more and more profits, stock
prices are likely to charge higher.
And to quickly gauge whether or not the stock market should head
higher based on earnings, all we have to do is monitor the earnings
"beat rate." That is, the percentage of companies beating analysts'
expectations for profits.
The bar's set low from last quarter, too. Only 58.7% of
companies beat earnings expectations, which is the lowest reading
since the bull market began, according to Bespoke Investment Group.
So any reading above 60% should propel stock prices higher.
~ Key Statistic #2: Revenue "Beat Rate"
Companies are finding fewer places to cut costs to boost
earnings. That means they'll be forced to boost profitability the
old fashioned way - by increasing sales.
Again, expectations are low heading into this quarter. Based on
estimates from FactSet, third-quarter revenue is supposed to be
flat. (At the beginning of the quarter, analysts originally
expected sales to grow about 2%. Blame Europe for the
reversal.)
Projections mean squat, though. What we want to track are the
actual sales results. They represent the clearest sign that demand
for goods and services is increasing - or at least hanging tight -
in the face of the European slowdown.
Here, too, we don't need to worry about reviewing every last
company report. We just need to track the revenue "beat rate," or
the percentage of companies beating analysts' expectations for
sales.
Like the earnings beat rate, the revenue beat rate came in last
quarter at the lowest level since the bull market began, at 48.4%.
Any reading above the long-term average of 61.8% should prove to be
another catalyst for higher stock prices.
~ Key Statistic #3: Guidance Spread
Since the stock market is a forward-looking beast, past results
don't matter as much as expectations for the future. And,
obviously, the market could use a healthy dose of optimism right
now.
The easy way to get a pulse on expectations for the future is to
track the guidance spread. That is, the difference between the
percentage of companies raising guidance and the percentage of
companies lowering guidance.
Simply put, a positive spread indicates that more companies are
optimistic about the future. And a negative spread indicates that
more companies are pessimistic.
As a frame of reference, the guidance spread has been negative
for the last four quarters. Before that, it was positive for nine
quarters in a row.
The end result? Any positive reading this quarter will go a long
way to push stock prices higher.
Bottom line: Even after a weaker-than-average second-quarter
reporting season, stocks managed to rally 6.5%, as investors had
already priced in the worst news. I'm convinced the same is going
to happen in the third quarter. With the bar set so low - along
with the
tendency for stocks to rise in the fourth quarter
of a presidential election year
- the market's poised to rally into the end of the year.
