How a V-Shaped Recovery in Earnings Will Boost Economy

Oct.27.10 | About: SPDR S&P (SPY)

By Barry Schwartz

Q3 earnings season has gotten off to a great start. According to Zacks Investment Research, 128 out of 159 S&P companies have delivered positive earnings surprises. And yes, we are seeing revenue growth. Excluding financial companies, revenue is up 10% year over year. For the full year, S&P firms should earn around $80 in 2010, up a remarkable 40% from 2009 and back to pre-recession levels. Folks, this is a V-shaped recovery.

With a little (well maybe a lot of) help from low interest rates, rising corporate profits will kick-start the US economy. Here’s what will happen. Right now American companies are sitting with close to $1 trillion in cash and non-financial company balance sheets are in their best shape in 50 years. Slowly buy surely, CEOs and CFOs will get fed up with collecting “bupkis” on their cash balances and will start to put the cash to work.

The first step will be to return some of that security blanket to shareholders in the form of dividend increases and stock buybacks. 299 companies increased their dividends during the third quarter, an increase of 56% from the same time last year, according to an analysis by Standard & Poor’s. If a company is worried about the future, the last thing it does is raise its dividend. The second step will be to use the low interest rate environment to invest in capital equipment, make acquisitions and, god willing, hire new employees.

The good news for investors is that stocks are attractive. The S&P 500 is trading at 14.7 times this year’s expected earnings. This is an 11% discount to the historical average since 1954 of 16.5 times. If, as expected, S&P earnings grow 15% in 2011, stocks have a lot more room to run. In fact, if corporate profits are this good in a lackluster economy, imagine what they will look like when the economy is healthy again.

Disclosure: No position