With just over one-fifth of S&P500 firms having reported results for Q2 2010, index earnings are forecast to come in at $19.94, an increase of about 47.7% (pro forma basis) versus Q2 2009, and up 3.2% sequentially. We calculate these figures using actual results where available and current consensus forecasts for firms that have not yet reported. Note that the S&P500 SPDR (SPY) trades at approximately 1/10th the value of the index; its earnings per share are also one-tenth.
Sales growth, which has been a major concern of Wall Street, looks to be up a healthy 10.4% year-on-year. However, excluding sales from Energy and Materials firms sales growth is 6.9%.
The Financial Sector (XLF) is likely to be the largest contributor to overall index earnings growth, with profits up some $22.8 billion, or more than 500% year-on-year. But this of course reflects easy comparisons. As a portion of total S&P500 earnings (i.e., not just earnings growth), the sector comes in second, behind Technology (XLK), and just slightly ahead of Health Care (XLV).
The Utilities Sector (XLU) is the only one expected to see a decline in profits, though its overall impact on the index is minor. Figure 1 shows the contribution of each sector to S&P earnings growth; Figure 2 shows the breakdown of overall index profits. What follows is our investment summary on each of the Select Sector SPDRs, based on long-term fundamentals and valuation metrics but not necessarily driven by Q2 results.
Lastly, as quarterly results are announced analysts adjust their full-year estimates for those and other firms. Table 1 has the latest updates of full-year 2010 EPS estimates, growth rates, and P/Es by sector.
|Figure 1: Profit growth by sector ($millions and %YoY)|
|Source: AltaVista Research|
|Figure 2: Composition of Q2 Profits by Sector ($millions)|
|Source: AltaVista Research|
Consumer Discretionary (XLY) - Estimates had been rising nicely but have recently stalled. In any case, expectations for this year and next, which imply record levels of profitability (for both margins and return on equity), appear overly optimistic given persistent unemployment and the shift by consumers away from debt in favor of saving. Meanwhile with its rich valuation multiples XLY continues to have the lowest ALTAR Score of any Sector SPDR.
Consumer Staples (XLP) - Profits are forecast to post their biggest increases in 2010 in at least five years, on modest but combined increases in both sales and profit margins. From a long-term perspective, XLP's rich price-to-book value multiple reflects the sector's relatively high and stable profitability (ROE), resulting in an ALTAR Score of about average. Nonetheless XLP is also the least volatile of the nine Sector SPDRs, giving it an attractive risk/reward profile overall in our opinion.
Energy (XLE) - Consensus estimates seem to imply the start of a new up-cycle, with rapid growth in sales exceeding 20% this year and with even faster growth in profits. But these estimates are highly uncertain and profitability (margins and ROE) is forecast to remain well below prior peaks. In any case, XLE enjoys an ALTAR Score well above average thanks to low valuation multiples relative to average profits of the sector over the course of the boom/bust cycle.
Financials (XLF) - Although profits will likely more than double in 2010, they will remain far below the levels of earlier in the decade, and the sector probably has more political risk than any other. Further, while the ALTAR Score suggests above average appreciation potential, investors should consider the high degree of uncertainty in estimates, as well as the possibility that return on equity (on which our rating is based) may in fact never return to its prior levels.
Health Care (XLV) - Consensus estimates suggest sales growth in 2010 could rebound by double-digits but a dip in margins will limit EPS growth. Further, the apparent trend towards lower profitability (ROE) bears watching because it implies slower earnings growth going forward longer-term. Nonetheless, XLV trades at historically cheap P/E multiples (not to mention at a discount to the S&P500) and enjoys an ALTAR Score well above average.
Industrials (XLI) - Sales may pick up modestly this year and next after a devastating double-digit decline in 2009, and with capacity utilization starting to recover margins could improve as well. Expectations have improved markedly in recent months. Still, return on equity is likely to recover only gradually, and in any case valuations appear to already reflect an eventual recovery, resulting in a roughly average ALTAR Score and risk/reward profile for this cyclical sector.
Materials (XLB) - Economic troubles in Europe may crimp the global recovery and therefore commodity prices, and as a result earnings estimates for XLB have dipped in the past month, but stock prices have fallen enough recently that the sector enjoys an above-average ALTAR Score. However we fail to see why this sector, subject to the same boom-bust forces as Energy firms (XLE), should enjoy a valuation premium given profitability (ROE) that, on average, is slightly lower.
Technology (XLK) - After a relatively mild and short-lived earnings decline, estimates are now rising handsomely. However, disappointments may result this year if Tech firms are unable to achieve the aggressive profit margins implied by analysts' consensus sales and EPS forecasts. In any case, XLK's lofty P/BV multiples more than reflect the sector's average profitability (ROE) resulting in a below-average ALTAR Score, although P/E multiples seem more reasonable.
Utilities (XLU) - Both sales and earnings should return to growth this year in concert with the overall economy, and valuations remain modest resulting in an above-average ALTAR Score. However, the outlook is particularly clouded by potential policy changes, from cap-and-trade emissions limits, nuclear permitting, investments in alternative sources, and higher taxes on dividends. Further, estimates have been declining for months, which is unusual for this sector.
Table 1: EPS estimates, growth rates and P/E ratios
|Ticker||2011E EPS||Change YoY (%) |
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