Don't Blame It On Earnings - Earnings Trends
Key Points:
• 4Q earnings season off to strong start, early results positive: 4.69 surprise ratio, 6.28% median surprise
• Earnings of reported firms up 84.8% year over year, remaining firms expected to show 148.8% increase
• Big earnings growth driven by Financials moving from loss a year ago to profits now, but even excluding the financial sector earnings are up 20.3% year over year
• Sequentially reported earnings up 4.9% but remaining firms expected to see 1.6% decline
• Strong 30.3% total net income growth expected for 2010, with 18.7% more expected for 2011 -- rebounding from -22.6% decline in 2008, -10.2% in 2009
• Rebounding earnings for Finance, Materials and Energy to lead 2010 charge
• Huge margin expansion in 4Q expected to continue in 2010 and 2011
• Total revenues expected to fall 9.0% in 2009, rise 4.6% in 2010, up 5.7% in 2011
• Revisions ratios fall to 1.78 for 2010 and 1.85 for 2011, total activity rising fast
• Autos, Business Service and Tech revisions strong
• Firms up/firms down ratio at 1.42 for 2010, 1.31 for 2011
• S&P500 expected to earn $548.2 billion in 2009, $714.4 billion in 2010, $847.9 billion in 2011
• Bottom Up estimates: $58.94 for 2009, $76.92 for 2010, $91.14 for 2011
• Top Down estimates: $57.45 for 2009, $75.92 for 2010, 86.50 for 2011
Welcome to the new Earnings Trends. We have decided to start focusing our analysis of the S&P 500 based on Zacks' own sector groupings rather than the S&P GICS sectors. There are 16 Zacks sectors and only 10 GICS sectors, so the new groupings will result in better granularity of the data. The old way simply grouped too many very different companies together. In addition, we for the first time are presenting top line as well as bottom line expectations and surprise information.
We use the convention of referring to the next full fiscal year to be completed as 2010, although not all firms are on December fiscal years. This can cause discontinuities in the data, particularly around this time of year. The data is based on FY1, not based on 2010, even though I may call it 2010 in the report.
Don't Blame the Market Slide on Earnings
The market has been in for some tough sledding in recent weeks, but it is hard to blame it on the earnings reports. With close to half (43.4%, or 217) of S&P 500 reports in, the year-over-year earnings growth has simply been fabulous at 84.8%, and the expectations from the remaining firms indicate that that number will rise much further by the time all is said and done.
The remaining firms are expected to post total earnings that are 148.8% higher than a year ago. Of course, that says as much about just how disastrous the state of the economy (and thus corporate profits) was a year ago as it says about things being good today.
However, even set against the expectations coming into this earnings season it has been an extremely good one. For every earnings disappointment there have been almost five positive surprises. Half of all the surprises (including the disappointments) have been more than 6.28%.
Even on the top line, things are coming in both better than last year and better than expected. Total revenues are 8.54% higher than a year ago among the 217 firms that have already reported, and positive revenue surprises are beating revenue disappointments by a margin of more than 2:1. Overall, 61.8% of all firms have reported higher revenues than a year ago. For all of the firms in the third quarter, that figure was below 30%.
Impressive Even Beyond Financials
While the dramatic growth in earnings is largely due to turnarounds in a handful of very large firms moving from big losses a year ago to profits this year, that is not the full story. Most of those big turnarounds were in the Financial sector. In total, the 41 finance companies that have reported so far have earned $8.74 billion this year, while those same firms lost a total of $20.51 billion a year ago.
However, even if we exclude the Financial sector, total earnings are up 20.3%. Companies reporting higher earnings than a year ago outnumber firms with falling earnings by a margin of more than 3:2. Earnings growth is dramatically higher than revenue growth, which means we are seeing a huge increase in net margins. That margin expansion is expected to continue, not only in 2010, but into 2011 as well.
Looking at full-year earnings, total net income is expected to be lower than that of 2008, but just by 10.2% -- a much smaller decline than the 22.6% plunge in 2008. This year will be one of earnings recovery, with growth of 30.3% expected, but note that that will still leave earnings below 2007 levels.
Recovery Looks Real
While the data is still relatively thin for 2011, and thus should be taken with a grain of salt, further growth of 18.7% is expected for total earnings in 2011. As for the top line, after a 9.05% plunge in 2009, revenues are expected to grow by 4.95% in 2010, followed by 6.32% growth in 2011.
In general, corporate revenue growth should be highly correlated with nominal GDP growth (although the S&P 500 certainly does not make up all corporate revenue in the country, nor do all of the revenues come from in the U.S.). It looks like the analysts are collectively expecting a fairly strong economic recovery over the next two years.
In 2010, the percentage growth numbers will be not really meaningful for the Auto and Construction sectors. Construction will be going from negative total earnings to positive total earnings. Autos managed to squeak out barely positive earnings for the full year in 2009, but the near zero total in the denominator means that the percentage growth will be astronomical.
Among the larger sectors, Basic Materials and the Financials are expected to be the growth leaders for the year (Financials did the "negative to positive" thing in 2009). Energy is also expected to see a large rebound in its total profits.
Together, Finance and Energy will account for more than half of all the incremental earnings in both 2010 and 2011, even though together they account for only slightly over 25% of the total market capitalization of the index. However, in the absence of mark-to-market rules, the quality of the earnings in the Financials is suspect. Do you file their book values under fiction or non-fiction?
Cost-Cutting Remains a Big Component
Cost cutting has been the major force driving earnings and earnings surprises. However, the costs to one company are either the revenues of another company or someone’s paycheck, which is then spent to create revenues for firms.
The bottom up data coming out of all these individual firms seems to confirm what we have been getting from the macro statistics from the government: the economy is growing due to increases in productivity. Higher GDP with fewer workers.
Productivity Numbers to Watch
With GDP growth of 5.7% in the fourth quarter, but a total of 208,000 jobs lost (or 0.16% of the total works as of 9/09) on a seasonally adjusted basis in the same quarter, the productivity numbers to be released this week should be extremely strong. However, on a non-seasonally adjusted basis, jobs actually did increase by 386,000 in the fourth quarter (there is a little-known bit of trivia for you).
For the productivity numbers, it will be the non-seasonally adjusted numbers that count. For understanding the overall state of the economy, it is the seasonally adjusted numbers you need to focus on. The cost cutting, including job cutting, that corporations have done over the last year has set them up for explosive earnings growth now that some revenue growth has returned.
Upward Revisions
The revisions ratios for both 2010 and 2011 are strong, and should give us confidence that those growth rates will actually be achieved, if not exceeded (although still early for 2011). Every sector but Utilities and Aerospace has seen more estimates raised for 2010 than cut, and the revisions ratio for 2010 stands at an extremely strong 1.78.
In other words, the positive earnings surprises are causing the analysts to raise their sights for the future. Unlike the other three quarters of the year, there is no “mechanical" reason to raise estimates in response to a positive earnings surprise, since the fourth quarter 2009 earnings are not part of the full-year 2010 earnings, the way the third quarter 2009 earnings were part of full-year 2009 earnings. The raising of the sights extends into 2011, where the revisions ratio stands at 1.85%.
The upward estimate revisions are not just in a handful of firms, either. The ratio of firms with rising estimates for 2010 to falling mean estimates stands at 1.42 for 2010 and 1.31 for 2011. The S&P 500 is selling for 14.1x consensus expectations for 2010, or an earnings yield of 7.09%, or almost twice the yield on the 10-year Treasury note (3.58%). The S&P is selling for just 11.9x consensus expectations for 2011. Stocks look very attractive, at least relative to bonds, at this point.
Scorecard & Earnings Surprise
• Less than half of reports in, but off to fairly strong start
• Earnings Surprise Ratio (#beat/#miss) at 4.69, very strong but below 3Q level
• Growth in scorecard is only for those firms that have reported
• Reported growth massive at, at 84.80% so far yr/yr, but that says more about a year ago than today; sequentially down 9.65%
• Median Earnings Surprise 6.28%, a very strong reading
• Year-over-year Earnings Growth Ratio (# Positive Growth/# Negative Growth) at 1.61, big improvement over recent quarters
In evaluating the data presented here, keep the percentage reported in mind. For some sectors, the sample size is extremely small. The move to the 16 Zacks sectors means that even when all reports are in, some of the sectors will still have relatively few firms in them. For firms with only a few reports in, the median surprise will be very volatile as new firms are added to the sample. This is particularly true now as only a handful of firms (mostly with November fiscal periods) have reported so far.
With 43.4% of the reports in, this has been a very strong earnings season so far (although one would not know that by looking at the market action). Yes, we had easy comps from a year ago, but 84.8% year-over-year growth is nothing to sneeze at.
Most of that eye-popping growth is due to a handful of firms, mostly in the Financials. However, even if the Financials are excluded earnings growth is still 20.3%.
A majority of firms are reporting higher earnings than a year ago. Earnings are coming in much better than expected, with 77.9% of all firms reporting coming in with better than expected earnings.
Growth
Reported
Median
Surp
Pos
Surp
Neg
Grow
Pos
Grow
Neg
Sales Surprises
• Sales Surprise Ratio at 2.23, median surprise 1.75%
• Total revenues rise by 8.54% year over year, rising revenue firms exceed falling revenue firms by 1.33 ratio
• Rising total revenues mostly due to the Financials
• Six sectors seeing revenues down double digits so far
• Tech leads in revenue surprises
Total revenues of the 217 S&P 500 firms that have reported are up a very strong 8.54%. This is mostly due to a handful of Financial firms that actually reported negative revenues last year. In distinct contrast to the third quarter -- when less than one third of all firms reported rising year over year sales -- this quarter, rising revenue firms out number decliners by 1.33:1. The fact that earnings have risen far more than have revenues means that we are seeing an explosion in net margins (or, more precisely, we are recovering from the collapse in net margins a year ago).
Growth
Reported
Median
Surp
Pos
Surp
Neg
Grow
Pos
Grow
Neg
Expected Quarterly Growth: Total Net Income
• S&P total net income to soar 148.8% from a year ago even when non-recurring items are excluded. Only those firms that have not reported 4Q earnings are included below. Combined with those that have already reported, it looks like earnings will more than double when all the reports are in
• Move from losses a year ago to profits this year in Finance and Autos responsible for most of the growth
• Cyclical Basic Materials to post huge (191.56%) year-over-year growth (low base)
• Positive yr/yr growth expected for 6 sectors, negative for 6; Industrials, Energy and Transportation to lag
• Earnings expected to fall 1.56%% from 3Q levels, but 5.54% sequential growth expected for 1Q
• The numbers in the table(and Revenue growth table) below only refer to those firms which have not reported yet. The numbers will shift as the sample size here falls and correspondingly increases among those that have reported
4Q 09 E
1Q 10 E
3Q 09 A
Quarterly Growth: Total Revenues
• S&P 500 Revenues (of unreported) expected to be down 0.5% year over year in 4Q
• Sequential revenue growth of 2.53% expected for 4Q, down 0.94% expected in 1Q
• Retail expected to take sequential revenue lead in 4Q, mostly due to seasonality
• Medical, Finance and Retail to post highest year-over-year revenue growth in 4Q
• Only 6 sectors expected to post positive year-over-year revenue growth in 4Q; 9 negative
• Construction revenues continue to be demolished
Keep in mind that these numbers only refer to those firms that have yet to report their 4Q results. As firms report, the sample of firms left to report will shrink, potentially causing big week to week changes in the expected (and even historical) growth rates. However, these tables are useful to look at to see which way the reported growth rates are likely to head by the time earnings season is over.
4Q 09 E
1Q 10 E
3Q 09 A
The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.
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