The Rapid Recovery (in Profits) - Analyst Blog

Corporate earnings are clearly recovering. They tend to do that after a recession. The graph below uses the “official” data on S&P 500 earnings from Standard and Poor's. The Zacks history is a bit different, since we look at the current composition of the S&P 500, while S&P uses the composition of the index at the time.

When looking at relatively short-term changes -- say quarter to quarter, or even year over year -- the Zacks way of looking at things makes more sense, but over longer historical periods, such a method breaks down as many of the current members of the S&P 500 did not even exist 10 or 20 years ago.

The graph shows the rolling 12-month operating “EPS” for the S&P 500 index. It includes an estimate for the fourth quarter of 2010 that incorporates the firms that have already reported. The S&P estimate is a bit more optimistic than the current Zacks estimate for all of 2010, which is the same thing as the rolling 12-month total as of the end of the fourth quarter, but the difference is not that huge. I used their estimate since I wanted to keep everything "apples to apples" in the graph.

The high point in the trailing EPS was in the second quarter of 2007 when they hit $91.47. The recession took a major toll, and by the third quarter of 2009, the rolling “EPS” had fallen by 56.7% to hit $39.61. Using the S&P estimate, they will have rebounded by 111.6% (or 108.6% using the current Zacks consensus estimate for FY0, which is mostly 2010, or $82.62, some of the discrepancy is due to the treatment of firms that don't have December fiscal year ends, most notably those with January fiscal year ends, and those are still FY1 in the Zacks system).

For FY1, which at this point is mostly 2011 earnings, the Zacks consensus is now looking for earnings of $94.77. That will put the total net income well above the previous peak.

So how does this recovery look relative to the last two recoveries? Extremely strong, as one can see from looking at the slope of the line since the most recent bottom relative to the slope of the line following either the 1991 or the 2001 recessions. Including the fourth quarter, we are now five quarters off the bottom in earnings, and based on the S&P numbers, earnings are up 111.6%.

Assuming the current Zacks estimates for 2011 prove correct, then the recovery nine quarters off the bottom will be 143.9%. It will also be 3.6% above the previous peak.

Five quarters after the end of the 2001 profit downturn, earnings had only recovered by 22.7%. However, the profit downturn in the 2001 recession was not as steep, with profits falling “only" 31.6%, from the third quarter of 2000 when they were $56.79 to the fourth quarter of 2001 when they hit $38.85. Nine quarters into the recovery after the 2001 recession bottom, profits were “only” up by 49.5%, although relative to the previous peak, the recovery is similar, being 2.7% higher.

The 1991 downturn was an even more modest affair, both in terms of the decline and the subsequent recovery. Back then, profits started to decline well before the actual recession hit, with the peak actually being in the second quarter of 1989 at $25.53, and they fell by only 24.4% by the fourth quarter of 1991. Five quarters into that profit recovery, they had only rebounded by 15.0% to $22.19. Even nine quarters in, profits were just 44.1% higher than the recession lows. On the other hand, by that point they were 9.0% higher than the previous peak.

Currently, analysts are raising their estimates on the S&P 500 firms for 2011 at a pace of almost two upward revisions for each cut. The fourth quarter earnings are coming in higher than expected. Thus it is likely that the estimates for both the fourth quarter of 2010 -- and for all of 2011 that are used in this graph -- are conservative, and the actual earnings (and hence earnings growth) are probably going to be higher than this analysis suggests.

Looking further out, the current Zacks estimate is for S&P 500 earnings to hit $106.17 for 2012, which would bring the 13-quarter recovery off the bottom to 168.0%, relative to actual 13-quarter recoveries of 79.7% following the 2001 recession and 72.2% following the 1991 recession. On the other hand, relative to the previous peak, earnings are expected to be up 16.1% rather than being up 22.9% following the 2001 downturn and up 30.1% following the 1991 recession.

Thus, the conclusion is that profits are recovering much more strongly this time around than they did following the last two recessions, but that is partially due to the fact that profits fell apart much more in the Great Recession than they did in either of the previous two downturns.

As a caveat, I would note that the S&P 500 earnings are a nominal number, not adjusted for inflation. Inflation during this recovery so far has been significantly lower than it was following the past two downturns, with the CPI up 2.01% between when profits bottomed in September 2009 and December 2010.

The comparable increases following the 2001 and 1991 recessions were 3.66% and 3.69%, respectively. Stripping out food and energy prices, the inflation differential is even bigger, up just 0.98% in the current recovery versus 2.18% following the 2001 recession and 4.22% after the 1991 downturn.