Earnings Surprises: Capitalism Is Alive and Well in America

I have to say that I’m pleasantly surprised by many of the results we’re seeing in week 2 of this vital earnings season. So far 67% of the 43 companies in the S&P 500 that have reported have beaten estimates.

As I have been spending some time collating earnings results to get a feel for the overall profit picture year-over-year (expectations going in were for a 34% drop in corporate profits), it’s worth noting some of the anecdotes that prove capitalism is still alive and well in America.

Financials - Goldman & J.P. Morgan, we bow down to you…

For starters, Goldman Sachs (GS) knocked the cover off the ball when it reported EPS of $4.93 per share versus estimates for $3.54; back out the $10 billion TARP repayment charge and the favorite voodoo doll of the Populist Party would have earned $5.71, up 25% YoY. Surprisingly, my Monday call for Goldman to earn $4 - which I though to be audacious at the time - turned out to be outright disrespectful.

Take That Goldman...and that!

J.P. Morgan (JPM) followed up yesterday with earnings that far surpassed expectations, coming in at $.28 versus the $.04 estimate. Revenue was up 41%, but EPS was down YoY on a much higher share count. It’s generally harder to attack JPM than Goldman because Jamie Dimon & Co. are actually in the business of commercial banking, while Goldman only has the shingle hanging on the door.

Good results aside, it’s worth noting that loan loss provisions were upped by another $8 billion at JPM, an amount equal to what was set aside in the first quarter. This reflects the continued weakness of the U.S. consumer as unemployment ticks ever closer to the Mendoza Line of 10%. I continue to worry about the widening gap between the haves & the have-nots in banking, but that is a discussion for another day. For now though, investors should beware thinking that the rest of the financials will report as impressively as GS and JPM.

Tech Continues To Shine

Technology companies continue to prove why the NASDAQ has outperformed the broader S&P 500 (and the DJIA...if anybody still actually cares about that silly index) for the past year to the tune of over six full percentage points. Intel (INTC) posted a fantastic quarter with gross margins well above expectations, and guided higher on revenues for Q3.

Bears will say this is just reflective of inventory restocking, but on a low-volume day Wednesday Intel’s report was the main catalyst pushing indexes 3% higher and crushing some of the stubborn shorts in the market. In related news IDC reported that global PC shipments were down only half as much as original estimates, coming in at -3% versus calls for a 6% drop.

You see, tech stocks have an inherent advantage in this market. While many sectors have taken their first punch in the face in 20 years (especially the financials), Tech firms remember all too well how they barely survived the dot-com collapse less than a decade ago. Like the wimp who gets sand kicked on him at the beach, they went to the balance sheet gym and have been beefing up, anxious to make sure they never meet the edge of the abyss again. This is why cash levels were so high (and debt levels so low) for most tech stocks heading into this recession, and why they’re much more prepared to lead our way out. Technology remains the largest sector weighting in the Secular Trends Portfolio, and I’m only seeing more reinforcing evidence of that during this earnings period.

What About the Little Guy?

It’s in the small & midcap area that I’m actually seeing the most concrete signs of “out of the woods-ness” for the domestic economy. Crown Holdings, Inc. (CCK) a packaging & bottling company, actually reported a year-over-year increase in profits on the back of impressive cost-cutting and an improvement in the balance sheet. This is a company I would have pegged as a definite miss going into earnings.

The same can be said for consumer-focused lumber products maker Universal Forest Products, Inc. (UFPI), which is seeing shares bid up 18% on shockingly impressive results. Despite a 26% drop in revenues, operating profits were up 19%. Why? Well, that’s what happens when you improve gross margins by 400 basis points and operating margins by 210 bp. The company has been aggressive in right-sizing their business for over a year, and is now reaping the results.

I’m not thrilled over the medium-term prospects for either company (or industry), but bonus profits lead us toward two all-important conclusions:

1. Stock multiples can start to find a tangible floor that buy-side investors can get their eggheads around
2. Extra tax revenue for state & federal government…every dollar, every extra percentage point above consensus estimates mean so very much right now.

Capitalism - Remember When it Wasn’t a Dirty Word?

There’s an important lesson to be learned here, and it involves a bit of behavioral finance. When publicly-traded companies are chugging along nicely, there’s an almost subconscious push to “take the foot off the brake”. But it’s the braking procedure where capitalism really proves its mettle. It’s in the braking that companies look over their cost structure and make hard choices. It’s where necessity shows its matronly charms. It’s where we are right now, as companies either iterate themselves to the next, better, leaner version of themselves, or face the wrath.

At some point, of course, we need more than improved margins - we need top-line growth. But in a world where demand can only be achieved through blunt force, profit potential is where the virtuous cycle must begin. Earn a profit today…Get the mind & money muscles primed…And all of a sudden it’s that much easier to roll that paper over, to fund an acquisition, and to (hopefully) hire a worker so as not to be understaffed when the recovery becomes obvious enough for USA Today to report on it. Because by then folks, it’ll be too late, and somewhere a competitor will be beating you to the punch.

Disclosure: author does not hold personal stakes in the companies mentioned.

Comments

[herbert hoover:]

Do you find it ironic that your headline trumpets the revival of capitalism in America yet the first two companies you discuss are JPM and GS who are in bed with the federal government and are provided unfair advantages over their competitors?

Jul 17 09:19 AM

[Trend Surfer:]

And to top it all, if I could lobby for an accounting change to allow me to defer realizing the market loss of my house, I'll still be considered a millionaire on paper.

Not to mention the fact that with the government's help, my competitors were eliminated and more customers created due to companies being 'influenced' to obtain billions of financing (stress test).

Jul 17 02:19 PM

[AndrewBaker:]

Cronyism is a better word when you are talking about GS: they and the government are massaging each other's bits to deceive us that things are getting better when they are only getting better for them: the rest of us are paying the bills and getting no return for it.

Yes, techs will do better because any company still going has to have the tools to do so: but it's a small part of a big economy in even bigger trouble.

Jul 17 02:46 PM

[MarkitWacha:]

JPM, BOA and GS are able to get funding at 0% and then buy US treasuries that pay > 3%.

Not only that, but they're on the mark-to-fantasy path.

Intel and the big techs have lots of cash to take advantage of engineering costs cut in half. They're hiring, in other words.

Intel also has the best chip available for the netbooks. That's giving it a spike in growth. You can get a netbook for the price of a really good power supply. Amazing.

Jul 18 11:21 AM

[snagglesnarf:]

Look closely at the "profits" of these companies and I'll bet a good chunk of it is taxpayer dollars going bye-bye.

Jul 18 04:58 PM