Quarter 2 Earnings Heading In The Wrong Direction - Week 3 Part I

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Includes: AA, AAPL, BP, CAT, CB, DD, DHR, GILD, LLY, MCD, MMM, RAI, TXN, UTX, VZ
by: Mark Bern, CFA

Summary

The trend in EPS growth is again turning south while earnings beats continue to dominate headlines.

The quarter is shaping up to be the fifth consecutive quarter of EPS declines year/over/year.

Forward guidance is painting another nasty picture for quarter 3 which now holds the distinction of being project by consensus to be the sixth straight quarter of declining EPS.

Extra caution should be taken when considering new equity purchases.

Click to enlarge

What to do now?

Once again Wall Street analysts are playing a shell game and investors looking for earnings growth are looking under the wrong shell. In earnings releases from Monday and Tuesday of this week I gathered data on 60 large cap stocks (above $4 billion). Last week the trend seemed to favorable but companies reporting then were not representative of the total market with few reports from lagging industries. This week there will be many more releases to consider representing a very broad swath of the economy. In total through the first two weeks of earnings reporting for the quarter, 68 percent of companies have beaten consensus estimates.

It is important for investors to understand that consensus estimates start high at the beginning of each year and, as each quarterly reporting period draws near, then get revised lower and lower until most companies can easily beat the consensus. It is a game played upon those not paying close enough attention. Will investors ever become wary of this game? I am trying to do my part to keep the truth front and center for my readers. Hopefully I can help a few understand the game being played with their money. It will work until it does not.

Of the 75 companies I review below 76 percent either met or beat estimates while 42.7 percent reported flat or negative growth in earnings per share [EPS] compared to the same quarter last year. Overall the average (unweighted) change in earnings for the companies listed below has been -1.9 percent year over year [y/o/y]. The blended expected EPS growth rate (average of actual of already reported EPS and estimates of those yet to be reported) at the end of last week stood at -3.7 percent (from FACTSET). That is an improvement from the -5.5 percent decline in EPS originally expected. But that bar was intentionally set low.

If you open the FACTSET link above and look at the graph near the top you will see that the S&P 500 Index price has diverged from even the adjusted earnings trend. Adjusted EPS are being reported by about 90 percent of Index component companies now, compared to about 70 percent just a few years ago and the difference between Generally Accepted Accounting Principles [GAAP] EPS and adjusted EPS has grown to 26 percent recently. Wall Street will spin this to be nothing to worry about as adjusted EPS is a better gauge of how a company operations are doing without all the messy reporting requirement of GAAP. In a few cases this may be true, but in most cases it just makes comparing a company's current EPS to past EPS and those of competitors much more difficult for investors. Thus, it is designed to make us all much more reliant on Wall Street for guidance. Remember, these are the guys who rarely downgrade a company until after the stock has cratered in value. Be careful who you listen to for investment advice.

As an example, Alcoa (NYSE:AA) has listed restructuring expenses in its income statements as one-time, non-recurring events for at least six years in a row. Many companies use such line items to move expenses out of operating results year after year. Some are using such tactics to produce growing EPS, along with company buybacks near record highs, to prop up company share price to justify multi-million dollar bonuses and stock option vesting. In the last few years companies have bought back more than $2 trillion of stock. This is another game that Wall Street tells us is a form of returning money to shareholders. Personally, in most cases, I would prefer that a company build up cash if there are presently no better alternative investments so that when competitors fall on hard time or the market crashes the cash can be put to work at bargain prices. An increase to dividends or a special dividend is returning cash to shareholders, buying back at the top is poor allocation of capital. We seem to have a lot of that lately.

Contained within the list below are some very large cap companies ($50 billion or more) that may be considered bell weather companies: Apple (NASDAQ:AAPL), Danaher (NYSE:DHR), Gilead Sciences (NASDAQ:GILD), Texas Instruments (NYSE:TXN), BP (NYSE:BP), Caterpillar (NYSE:CAT), Chubb (NYSE:CB), E.I. DuPont (NYSE:DD), Eli Lilly (NYSE:LLY), McDonald's (NYSE:MCD), 3M (NYSE:MMM), Reynolds American (NYSE:RAI), United Technologies (NYSE:UTX) and Verizon Communications (NYSE:VZ).

Symbol

EPS Date

Est. EPS

Act. EPS

% Surprise

Yr. Ago EPS

% chg. y/o/y

ACC

25-Jul

$ 0.53

$ 0.54

1.9%

$ 0.57

-5.3%

AVB

25-Jul

$ 2.09

$ 2.03

-3.0%

$ 1.87

8.6%

BRX

25-Jul

$ 0.50

$ 0.50

0.0%

$ 0.49

2.0%

CDNS

25-Jul

$ 0.28

$ 0.29

3.4%

$ 0.27

7.4%

CE

25-Jul

$ 1.55

$ 1.59

2.5%

$ 1.58

0.6%

CNI *

25-Jul

$ 1.04

$ 1.11

6.3%

$ 1.15

-3.5%

COL

25-Jul

$ 1.59

$ 1.63

2.5%

$ 1.33

22.6%

DHR

25-Jul

$ 1.09

$ 1.25

12.8%

$ 1.07

16.8%

ESRX

25-Jul

$ 1.57

$ 1.57

0.0%

$ 1.44

9.0%

EXP

25-Jul

$ 0.86

$ 0.93

7.5%

$ 0.75

24.0%

GILD

25-Jul

$ 3.02

$ 3.08

1.9%

$ 3.15

-2.2%

KMB

25-Jul

$ 1.48

$ 1.53

3.3%

$ 1.41

8.5%

KRC

25-Jul

$ 0.85

$ 0.87

2.3%

$ 0.82

6.1%

LECO

25-Jul

$ 0.83

$ 0.83

0.0%

$ 0.95

-12.6%

LVS

25-Jul

$ 0.56

$ 0.52

-7.7%

$ 0.60

-13.3%

RE

25-Jul

$ 2.72

$ 3.17

14.2%

$ 5.03

-37.0%

ROP

25-Jul

$ 1.61

$ 1.56

-3.2%

$ 1.70

-8.2%

S

25-Jul

$ (0.08)

$ (0.08)

0.0%

$ (0.01)

-700.0%

TXN

25-Jul

$ 0.72

$ 0.76

5.3%

$ 0.65

16.9%

WAB

25-Jul

$ 1.04

$ 1.00

-4.0%

$ 1.04

-3.8%

WRB

25-Jul

$ 0.79

$ 0.82

3.7%

$ 0.81

1.2%

AAPL

26-Jul

$ 1.39

$ 1.42

2.1%

$ 1.85

-23.2%

AMP

26-Jul

$ 2.27

$ 2.23

-1.8%

$ 2.33

-4.3%

AOS

26-Jul

$ 0.91

$ 0.98

7.1%

$ 0.79

24.1%

APC

26-Jul

$ -0.77

$ -0.60

22.1%

$ 0.01

-N/A

ASH

26-Jul

$ 2.07

$ 1.95

-6.2%

$ 1.91

2.1%

AVY

26-Jul

$ 1.01

$ 1.09

7.3%

$ 0.91

19.8%

AXTA

26-Jul

$ 0.34

$ 0.34

0.0%

$ 0.34

0.0%

BAX

26-Jul

$ 0.39

$ 0.46

15.2%

$ 0.19

142.1%

BEAV

26-Jul

$ 0.82

$ 0.84

2.4%

$ 0.75

12.0%

BP

26-Jul

$ 0.26

$ 0.23

-13.0%

$ 0.43

-46.5%

CAT

26-Jul

$ 0.86

$ 1.09

21.1%

$ 1.40

-22.1%

CB

26-Jul

$ 2.26

$ 2.25

-.04%

$ 2.40

-6.3%

CHKP

26-Jul

$ 1.07

$ 1.09

1.8%

$ 0.99

10.1%

CHRW

26-Jul

$ 1.00

$ 1.00

0.0%

$ 0.94

6.4%

CNC

26-Jul

$ 1.08

$ 1.29

16.3%

$ 0.76

69.7%

CNHI

26-Jul

$ 0.11

$ 0.16

31.3%

$ 0.13

23.1%

CTXS

26-Jul

$ 1.14

$ 1.20

5.0%

$ 1.00

20.0%

DD

26-Jul

$ 1.10

$ 1.24

11.3%

$ 1.09

13.8%

DTE

26-Jul

$ 0.90

$ 0.98

8.2%

$ 0.76

28.9%

EEFT

26-Jul

$ 0.90

$ 0.97

7.2%

$ 0.78

24.4%

EQR

26-Jul

$ 0.77

$ 0.76

-1.3%

$ 0.85

-10.6%

EW

26-Jul

$ 0.70

$ 0.76

7.9%

$ 0.57

33.3%

FCX

26-Jul

$ (0.01)

$ (0.02)

50.0%

$ 0.14

-114.3%

FIS

26-Jul

$ 0.86

$ 0.90

4.4%

$ 0.74

21.6%

HOT

26-Jul

$ 0.73

$ 0.71

-2.8%

$ 0.69

2.9%

HUBB

26-Jul

$ 1.43

$ 1.53

6.5%

$ 1.56

-1.9%

ILMN

26-Jul

$ 0.73

$ 0.86

15.1%

$ 0.80

7.5%

JBLU

26-Jul

$ 0.49

$ 0.53

7.5%

$ 0.44

20.5%

KEY

26-Jul

$ 0.28

$ 0.27

-3.7%

$ 0.24

12.5%

KKR

26-Jul

$ 0.10

$ 0.23

56.5%

$ 0.88

-73.9%

LLY

26-Jul

$ 0.85

$ 0.86

1.2%

$ 0.90

-4.4%

LPT

26-Jul

$ 0.64

$ 0.68

5.9%

$ 0.67

1.5%

MAS

26-Jul

$ 0.42

$ 0.46

8.7%

$ 0.38

21.1%

MBLY

26-Jul

$ 0.15

$ 0.17

11.8%

$ 0.10

70.0%

MCD

26-Jul

$ 1.37

$ 1.25

-9.6%

$ 1.26

-0.8%

MMM

26-Jul

$ 2.08

$ 2.08

0.0%

$ 2.02

3.0%

NLSN

26-Jul

$ 0.71

$ 0.71

0.0%

$ 0.66

7.6%

PCAR

26-Jul

$ 1.03

$ 1.06

2.8%

$ 1.26

-15.9%

RAI

26-Jul

$ 0.61

$ 0.58

-5.2%

$ 1.02

-43.1%

RNR

26-Jul

$ 2.01

$ 1.55

-29.7%

$ 2.18

-28.9%

RRC

26-Jul

$ -0.20

$ -0.14

30.0%

$ 0.01

-N/A

SIRI

26-Jul

$ 0.04

$ 0.03

-33.3%

$ 0.02

50.0%

ST

26-Jul

$ 0.72

$ 0.73

1.4%

$ 0.73

0.0%

TGNA

26-Jul

$ 0.49

$ 0.50

2.0%

$ 0.30

66.7%

TROW

26-Jul

$ 1.13

$ 0.76

-48.7%

$ 1.24

-38.7%

TWTR

26-Jul

$ 0.10

$ 0.13

30.0%

$ 0.10

30.0%

UA

26-Jul

$ 0.01

$ 0.01

0.0%

$ 0.03

-66.7%

USG

26-Jul

$ 0.48

$ 0.46

-4.3%

$ 0.43

7.0%

UTX

26-Jul

$ 1.65

$ 1.82

9.3%

$ 1.67

9.0%

VLO

26-Jul

$ 1.01

$ 1.07

5.6%

$ 2.66

-59.8%

VZ

26-Jul

$ 0.93

$ 0.94

1.1%

$ 1.04

-9.6%

WAT

26-Jul

$ 1.45

$ 1.58

8.2%

$ 1.32

19.7%

$ 69.86

$ 71.24

-1.9%

*CNI earnings per share stated in Canadian.

Click to enlarge

I find it very interesting that AAPL jumped by nearly seven percent on the day of the announcement because EPS beat expectations while EPS actually declined by 23.2 percent y/o/y. That is the power of the beat message! Of course, I did not mind this particular outcome since I own shares of AAPL for the long term. I expect the company to do better than expected and EPS to increase y/o/y for the remaining two quarters of the calendar year. Many consumers are waiting for the September release of the new iPhone. Sales are always muted in the last few months prior to a new iPhone release, but then the company has trouble keeping up with demand again and the stock gets another bump as sales and EPS surge once again.

The next few days will include about 90 earnings reports a day so stay tuned as we could learn a lot about the trend over the remainder of this week. Once I get through the heaviest part of earnings season I want to do a scaled down analysis of the trends in Q2 EPS estimates from a year ago to present. I also want to show a comparison of adjusted EPS earnings versus GAAP EPS for selected companies for perspective.

Here are the links in case you want to look through the previously reported earnings from last week or week one of reporting season.

As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.

For those who would like to learn more about my investment philosophy please consider reading " How I Created My Own Portfolio Over a Lifetime, or for those who would rather listen to a podcast on the same subject, you may want to consider my interview by IITF.com which can be found here.

Disclosure: I am/we are long AAPL, GILD.

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.