by Robert J. Martorana, Portfolio Manager at Right Blend Investing.
Consensus expectations for 2014 earnings for the S&P 500 (NYSEARCA:SPY) appear reasonable at 10%, but an analysis by sector shows that earnings growth is narrow, relying heavily on Financials and Consumer Discretionary (mainly catalog and Internet retail). Here are some other things that struck me about the S&P earnings data:
o Weak Capex: At this stage in the economic cycle, capital spending should be contributing to broad-based growth. But only the energy sector is spending aggressively.
o Weak banks: Bank lending should also be contributing, but lending is sluggish due to the aftermath of the crisis. So middle-market firms are turning to non-bank lenders.
o Cash hoards: Firms in tech and healthcare are sitting on huge piles of cash but are not spending or acquiring. (This may be good or it may be bad: The firms are showing capital discipline, but are not contributing to a healthy ecosystem in their sectors or in the economy.) What would trigger spending? Lower valuations, better organic growth prospects, or a change in tax regimes to allow repatriation of cash held overseas.
Valuation for the SPY is above trend, but that's to be expected at this stage of an economic expansion. Meanwhile, the dividend outlook is bullish, based on payouts, cash flows, and balance sheets. The details for earnings, dividends, and balance sheets are below, based on data from:
· Standard & Poor's
o These reports are written by data maven Howard Silverblatt, who contributed additional material used in this article.
· Consensus range is tight: The 2014 top-down EPS estimate for the S&P 500 is $118.16 (by market strategists), while the bottom-up estimate is $119.81 (by industry analysts). This puts year-on-year EPS growth in 2014 at 10.5% with revenue growth at 4%. A tight range makes some folks nervous, and could be a sign of complacency.
Earnings revisions in Q4 were neutral: Estimate cuts were about 4%, in line with historic averages. It is common for estimates to be trimmed in a rising market (see·Jan 3 report). Negative guidance in Q4 came from 97 companies, with positive guidance from 13.
· Historic S&P Earnings: In the chart below, the solid bar shows projections for EPS 1-year in advance, and the striped bar shows the actual reported EPS. Conventional wisdom says that bottom-up estimates have an optimistic bias, but I believe that this is no longer true after Sarbanes Oxley and after adjusting for recessions. I base this on Jeff Miller's excellent research on earnings optimism. Jeff challenges conventional wisdom that estimates from sell-side analysts are consistently high at the beginning of each calendar year. (Take a look-you won't regret it).
Earnings Growth by Sector: What Caught My Attention
· Telecom: Verizon has a disproportionate impact on Telecom. Without Verizon, 4Q EPS growth drops from 14% to 6%.
· Energy: Sector has 1% revenue growth in 2014, due partly to a 6% drop in revenues in refining/mktg. 4Q EPS to be down 8%, led by Exxon. Without Exxon, EPS down 5%.
· Healthcare: Highest projected rev growth in 2014 at 6.4%. Sector has 4Q revenue growth of 4%, led by Biotech and HealthCare.
· Consumer Discretionary: 2014 revenue growth projected to be 6%. Internet and Catalog Retail up 22% in 4Q! MultiLine Retail to post slightly negative rev growth in 4Q.
· Financials: This sector is driving 4Q earnings with 24% growth. Without financials S&P earnings growth in 4Q drops from 6% to 3%. Insurance earnings up 56% in 4Q (projected).
o 4Q Revenue Drag from Prudential: Year-ago pension income boosted 4Q2013 by $35 billion (not a typo). Pru is depressing rev growth in financial sector by 10% and the entire S&P 500 by 0.6%.
· Tech: Best revenue growth in 4Q at 4%, led by Internet/Software at 19%.
o Forex Hurts Software EPS: The Yen is down 25% year-on-year, from 80/$ in 4Q 2012 to 100/$ in 4Q 2013. Oracle, Red Hat, and Adobe noted this in the 3Q.
· Industrials: Sector has broad-based growth and modest expectations for 2014 EPS of 9%.
Current valuations are above historic trends, as shown in chart below.
o Top-down estimate is $118.16 by market strategists => forward P/E of 15.5x
o Bottom-up estimate is $119.81 by industry analysts => forward P/E of 15.3x
· P/E is based on closing price for S&P 500 on 12/31/13 of 1838.46.
Dividend Signals Remain Bullish
· Payout ratios are 36% for the S&P 500, below the historic average of 52%.
· Balance sheets also strong, with cash rising to over $1.3 trillion (see chart below).
· Cash flows are strong, especially in tech and healthcare. Capex is restrained (except in energy), leading to strong free cash flow generation in every sector except materials and health care.
· Tech dividends accounted for 15% of 2013 dividends (more than utilities and telecom combined).
· Financial dividends rose sharply in 2013, with 80 firms raising dividends and 2 decreasing dividends. The sector's recovery from the crash is picking up steam.
· Dividends account for 1/3 of total returns since 1989. Dividends accounted for all the returns in the telecom and utility sectors, and about half of returns in the materials and financial sectors.
Tech accounts for 15% of 2013 dividends
Source: Standard & Poor's
Financial Dividends Are Rebounding: 79 increases 2013 YTD
Source: Standard & Poor's
Dividends account for 1/3 of total returns since 1989
Source: Standard & Poor's
Balance sheets are excellent
(Factset Balance Sheet Insight 12/19/13)
Big piles of cash in tech land: Firms with high amounts of cash and cash flow
o Microsoft (NASDAQ:MSFT) up $14 billion in 3Q to $80B
o Apple (NASDAQ:AAPL) up $11 billion in 3Q to $41B
o Google (NASDAQ:GOOG) up $11 billion in 3Q to $56B
o Intel (NASDAQ:INTC) up $9 billion
o Oracle (NYSE:ORCL) up $8 billion
o EMC Corporation (NYSE:EMC) up $5 billion
o Other firms in top 10: General Electric (NYSE:GE) with $86B, Verizon (NYSE:VZ) with $57B; Cisco (NASDAQ:CSCO) with $48B, Ford (NYSE:F) with $37B, Pfizer (NYSE:PFE) with $33B and General Motors (NYSE:GM) with $30B.
Exxon Mobil (NYSE:XOM) showing negative CF in 3Q . Energy is a high-capex industry and falling oil prices are hurting profits. Energy accounts for 1/3 of all capex in S&P 500! XOM had negative $7.5 billion in cash flow during the third quarter. The reason is due to buybacks and dividends. XOM has had buybacks and dividends of $29 billion during the last 12 months, so it has heavy demands on its cash.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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