Earnings Upside Surprises May Not Always Equal Real Growth

On Tuesday, I listened to a "popular stock market commentator at a very popular business television media network" underscore that the high percentage of earnings surprises throughout the second quarter of 2009 as a valid sign that things are turning positive.

Based upon my daily analysis of earnings surprises for a universe of 7500+ stocks, I had my doubts and decided to sample the S&P 1500 components and examine each stock’s most recent report of quarterly results in terms of net earnings and sales.

Below is a table that summarizes the results:

While I like to think that the results speak for themselves, here is my intepretation:

1. EPS Results Reported: @ 81% of companies actually generated positive results for their most recent reported quarter while @ 18% showed a loss. A change in FASB accounting rules benefited @ 17% of these companies in the S&P 1500 index which comprises financial sector related companies. However, the annualized earnings growth rate (see # 3 below) saw more declines rather than increases, so the high percentage of positive results is somewhat of a distortion of the true situation.

2. Quarterly EPS Surprises: @ 62% of companies delivered upside earnings surprises and 28% failed to meet consensus estimates. This should come as no big surprise as Wall Street’s analysts are notorious for overshooting estimates during bull markets and underestimating them during bear markets. Up until the beginning of March 2009, the downward spiral of stock prices ushered in extreme amounts of pessimism. At the very least, I would hope these companies could meet or beat their handicap.

3. Quarterly Sales Surprise: Only @ 36% of companies exceeded consensus estimates for sales. The majority, i.e. @ 53% failed to meet expectations. The above percentage of earnings upside surprises contradicts this trend. Granted, serious restructuring and ruthless cost cutting has been implemented, but this will only take a company so far and should not be misconstrued as growth.

4. Quarterly EPS Growth % vs. Last Year: Speaking of growth, year-over-year earnings growth for the most recent quarterly reports was only evident in @ 38% of stocks while @ 57% of these companies saw a decline in the growth rate of their net profits.

5. Quarterly Sales Growth % vs. Last Year: Top line growth corroborates the patterns one sees in the above earnings growth trends. @ 25% of the S&P 1500 components experienced annualized revenue growth as @ 57% of them saw a contraction in sales.

Now, it is not my intention to rain on the parade of the bulls, but I do think it would be prudent to temper expectations despite the stock market being a leading indicator on the prospects of future earnings. Lest we forget, new economic cycles are based upon growth which is measured by the top and bottom lines of income statements. The existing sales and earnings trends for equities indicate a different story from what is being touted in the media as a solid 2nd quarter.

Besides this, the skeptic in me is reluctant to accept the forward consensus estimates from the very same analysts who originally underestimated the earnings on @ 80% of the S&P 1500. Caution tells me that they will need more time before they get a more realistic grasp on the economic realities of the new normal. In the meantime, just remember that earnings upside surprises may not always equal to real growth.

Comments

[aldol:]

perhaps the title would read better with equate in stead of equivocate

Jul 01 09:50 AM

[TATyszka:]

Nice 1st comment, 316278.

: - )

Jul 01 11:27 AM