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Q4's
Earnings Report Card - Hints & Red Flags |
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With the majority
of last quarter's earnings reports now posted, it may be worth investing
a little time to study - and we mean really study - just how they
came out. Why? They hold some important clues about the future.
It's no big
secret that earnings last quarter were better than earnings from the same
quarter a year ago, as well as better than expected for this year.
What's not as readily realized, however, is which sectors improved
the most, which sectors doled out the biggest surprises, and which sectors
fell short of all expectations.
We'll get to
all of that. First though, let's start with the basics.
With
nearly all of the stocks in the S&P 500 having reported their numbers,
72% have topped analysts' estimates, while 21% fell short of forecasts.
Both were close to records, pointing to a widening gap between strong and
weak results.
 As
for a raw number, the S&P 500 is going to earn about $16.77 per share
for the quarter on an operating basis, and is going to earn about $15.51
on a GAAP basis. Both are slight adjustments to the numbers
we posted last week. The respective annualized P/E ratios roll out
to 16.6 and 18.0.
Overall, it's
definitely a step in the right direction. On the other hand, with
massive cost-cutting initiatives on the table, is it possible that corporate
America is simply shrinking its way to success? Three quarters ago, the
answer would have been yes. Now, however, we can say the growth is real....
even if modest.
Total revenue
was up 4.9% last quarter. Granted, comparing Q4-2009 to Q4-2008 is
a ridiculously easy comp to top, but still, it shows progress.
Lots of sectors
you'd expect to do better did indeed do better. Information technology
stocks grew earnings by about 58%, and basic materials earnings grew by
about 78% last quarter. Revenue was up 8.8% and down 0.1%, respectively.
Both areas posted upside surprises, fueled by economic growth and/or inflation,
and/or easy comparables.
 The
biggest turnaround story, however, came from the consumer discretionary
sector. The sector's earnings rebounded 110% last quarter... more than
twice
the improvement expected. Sales grew by 4.0%.
Given the combination
of revenue growth and earnings growth, fourth quarter's results bode very
well for the tech and consumer discretionary sectors. And, both
are arenas that stand to do well at this stage of a recovery. We expect
more positive surprises going forward (which is saying something, since
89% of technology stocks and 94% of cyclical stocks posted upside surprises
for the prior quarter).
The fact that
basic materials stocks saw declining revenue despite stronger commodity
prices, however, is a major red flag. Yes, higher earnings could mean better
management of cash flow, but very poor results a year ago makes big improvements
easier to muster now. Between inflation (or lack thereof), ever-changing
expectations, excessive speculation, and so-so performance compared to
other sectors last quarter, the basic materials sector may simply be overrated
right now (more on that below).
Stunningly,
some sectors managed to do worse in the fourth quarter of 2009 than
they did in the fourth quarter of 2008.... earnings-wise and revenue-wise.
 Telecom
was one of the biggest losers, shrinking income by 30% despite a 3.9% improvement
in revenue. It's a testament to higher costs and mismanagement of spending
and internal investments. That said, we've also observed that the large
cap names in the group are the ones doing most of the back-sliding. Many
of the smaller names in the telecom sector (wireless and fixed line)
are actually doing well. So, don't generalize too much.
Energy stocks
also saw earnings shrink by about 30%, with only a 1.7% increase in revenue.
Neither are encouraging. If anything, both should have been strong
in comparison, as gasoline usage and oil prices should have been
stronger compared to the last quarter of 2008.
What gives?
One possibility is that the oil companies really were gouging consumers
late in 2008, and - frankly - they now realize they can't continue
doing it and reaping the excessive reward. Another possibility may simply
be that these companies just aren't doing as well as they were, as the
recovery has been soft thus far.
Either way,
until it's crystal clear the recession is over, the energy sector is apt
to fall short of expectations going forward in 2010.
And finally,
the industrials saw income shrink about 8% on a 4% dip in sales. This certainly
doesn't point to 'recovery spending' levels from business just yet. However,
the tepid declines don't scream 'stay away' either. Just choose carefully.
And where do
the financial stocks rank in the 'improvement' pile? There's no answer,
because it's impossible to measure meaningful 'improvement' when the sector
was a net loser for the comparable quarter a year earlier. Just for the
record though, the sector's revenue was up 23% last quarter, and earnings
did turn positive.
While the sector
as a whole is looking better, we still see a few rebounding companies
carrying more (ok, most) of the group's weight than they can carry
indefinitely. In fact, when you start to break the sector down into its
individual industries, the gap between the winners and lowers is widening.
As for what
this means to investors, there is opportunity within the sector,
but the sector itself is not an opportunity as a whole right
now.
With the exception
of the basic materials sector and the special care needed with the financial
stocks, we're taking all the trends we discussed above at their face value.
Any sector we didn't mention above could be considered neutral from our
viewpoint.
That said, there
is one dimension worth adding to the analysis.
 While
improving earnings and revenues are important, if a stock is too expensive
then it's still too expensive. To that end, on the nearby table you'll
find 2009's operating P/E ratios by sector (which are almost entirely complete),
and 2010's estimates (which have been updated as of last quarter's results).
Much of the
time one would expect this P/E analysis to perhaps trump another form of
analysis. In this case though, the valuations - now and later -
pretty much support our outlook described above.
For instance,
though the tech sector did very well last quarter, the current P/E of 19.4
is very affordable by technology stock standards, and the projected P/E
of 14.7 is very plausible just because these companies are close to those
results now.
Conversely,
the fact that energy stocks and basic materials stocks did so poorly last
quarter - and last year - forces investors to question whether or
not the forecasted P/E ratios are plausible - in the shadow of rich
P/E levels for the last twelve months - for those groups. Can either
of these groups really almost double earnings in 2010 as suggested?
Based on what we saw last quarter, probably not, meaning these stocks are
a recipe for disappointment.
Things can and
do change as time wears on, but we now have enough data to make a fair
assessment of different sectors' health. In short, the men are being
separated from the boys. That's great news for stock-pickers, and bad
news for certain sectors.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
