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

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Includes: AMGN, BA, CMCSA, FB, KO, MDLZ, MO, NEE, NOW, PXD, SO, SPG
by: Mark Bern, CFA

Summary

ServiceNow reported a loss but beat earnings and a drop in EPS of 207 percent from the same quarter last year but the stock jumped over 10 percent. Rational?

The trend remains positive so far with both beats and earnings coming in positive overall without weighting being considered.

The trend could change in the next two day with energy majors reporting.

The Fed has built a firm foundation and nothing can possibly topple the economy!

If you scroll down the table below you may find some interesting data. A few lines jumped out at me. ServiceNow (NYSE:NOW) had a consensus loss of $0.22 per share which the company beat handily by 31.8 percent by posting a loss of $0.15 per share. In the same period a year ago the company posted positive earnings per share [EPS] of $0.14 per share. The current result represent a $0.29 per share decline in earnings, or -207.1 percent change. And, of course, the shares surged higher by more than 10 percent after the press release. I do not follow NOW so I cannot explain the reaction. But just looking at the numbers it makes little sense to me.

Then I noticed Pioneer Natural Resources (NYSE:PXD), a good company within a very difficult industry at the moment. The consensus EPS called for a loss of $0.34 but the company reported a loss of only $0.22 per share. During the same quarter a year earlier PXD reported a positive EPS of $0.10. The stock is up about eight percent since the close on Wednesday before it reported. It is up over 28 percent in the last year from $126.77 on July 31, 2015 to $162.57. Now I realize that investors are pay for future earnings. That is how this game works. What I do not understand is why these companies are worth so much more when losing money than when making money. I will gladly ready all comments that explain this logic.

This series of article about earnings season is intended to help uncover the shell game that Wall Street continues to play with investors. Sell side analysts keep showing us the pea under the shell every year at the beginning of the year, telling us that by this time next year earnings will be much stronger. Then, after a year passes investors never seem to notice that those promises (consensus estimates) of rising earnings have been lowered and lowered and lowered until flat or even declining from the previous year. Then they show us that pea again and tell us to double down because they are sure we can follow the shell with the pea this time. Just give it another try! And here we are again, on the verge of a fifth consecutive quarter of declining earnings for the S&P 500 year-over-year [y/o/y].

The second shell game that too many investors have bought into is the one where we are told that when a company buys back its stock at record highs it is "returning money to shareholders." Let me explain what happens to that money when the price of that stock falls: it disappears! When five percent of the stock is bought back by the company at a near record high price and paid for with cash from new debt issues it changes the capital structure for the long term. The impact on share price is temporarily positive but when interest rates rise and the economy enters a recession those capital allocations will no longer appear so brilliant. If a company finds itself with too little cash and too much debt at some point in the future what will management do? Issue more shares and dilute the shareholders. This is a dangerous cycle and a game that Wall Street and corporate executives play with investors that is far more toxic to future valuations than we are being told.

Some companies that have very low debt levels and relatively high dividends can actually reduce the weighted average cost of capital by borrowing when rates are low and buying back shares. But there is a limit beyond which it becomes dangerous. Those in such a strong position are far fewer than those that are trying to act the part. My whole point is that this market is more dangerous and more highly valued than it should be.

Sure, low interest rates and low inflation can justify higher valuations to a certain extent. But how much higher depends upon how long that environment can continue. I must submit, though, that I do not believe that stocks in general are worth more than they were a year ago if earnings have declined over that same period. I continue to hold shares in a few companies that I consider to be not overvalued based upon a number of factors such as growth in revenue and free cash flow, balance sheet strength relative to peers, dividend yield and growth and efficiency of capital allocation to name a few. There are few companies that interest me these days. Those positions that I continue to hold I have hedged in case the economy falls into recession and markets decline. I am not predicted when it will happen, but have been at this for more than three decades and my experience tells me that recessions are not a thing of the past. When the next one comes it could be a doozy! I recommend caution.

This week the unweighted average change y/o/y for EPS for the stocks listed below is a positive 5.4 percent. This is the best result so far in the series. In previous articles I reported negative change, or declining EPS y/o/y but at a rate better than consensus. The trend has continued to be better than expected. But expectations are a bar that is low enough that most companies can easily clear. That is the whole purpose of Wall Street and it shell game of showing us the EPS pea and then making it disappear while investors watch.

There were a large number of companies reporting in week three. Of them I include 77 companies with market caps above $5 billion. Of those 77 companies, 24 missed on consensus earnings (31.2 percent) and 26 (33.8 percent) reported declining EPS from a year ago. The good news, if you can call it that, is that the average, unweighted EPS change y/o/y was a positive 5.4 percent. That number has been running negative in prior lists. But I cannot get too excited since this list represents only one day of earnings reporting; one data point does not a trend make.

The list below includes on Wednesday a few very large cap companies ($50 billion or more): Amgen (NASDAQ:AMGN), Boeing (NYSE:BA), Comcast (NASDAQ:CMCSA), Facebook (NASDAQ:FB), Coca Cola (NYSE:KO), Mondelez (NASDAQ:MDLZ), Altria (NYSE:MO), Nextera Energy (NYSE:NEE), Southern Company (NYSE:SO) and Simon Properties (NYSE:SPG). I list widely held companies as a convenience.

Symbol

EPS Date

Est. EPS

Act. EPS

% Surprise

Yr. Ago EPS

% chg. y/o/y

ABX

27-Jul

$ 0.14

$ 0.14

0.0%

$ 0.05

180.0%

ACGL

27-Jul

$ 0.98

$ 1.13

15.3%

$ 1.16

-2.6%

ALSN

27-Jul

$ 0.63

$ 0.36

-42.9%

$ 0.30

20.0%

AMGN

27-Jul

$ 2.74

$ 2.84

3.6%

$ 2.57

10.5%

ANTM

27-Jul

$ 3.24

$ 3.33

2.8%

$ 3.10

7.4%

BA

27-Jul

$ (0.88)

$ (0.44)

100.0%

$ 1.62

-127.2%

CA

27-Jul

$ 0.61

$ 0.64

4.9%

$ 0.64

0.0%

CMCSA

27-Jul

$ 0.82

$ 0.83

1.2%

$ 0.84

-1.2%

CSGP

27-Jul

$ 0.82

$ 0.91

11.0%

$ 0.69

31.9%

DLB

27-Jul

$ 0.51

$ 0.76

49.0%

$ 0.49

55.1%

DPS

27-Jul

$ 1.19

$ 1.25

5.0%

$ 1.14

9.6%

DRE

27-Jul

$ 0.30

$ 0.30

0.0%

$ 0.28

7.1%

EFX

27-Jul

$ 1.36

$ 1.43

5.1%

$ 1.15

24.3%

EXR

27-Jul

$ 0.92

$ 0.94

2.2%

$ 0.75

25.3%

FB

27-Jul

$ 0.82

$ 0.97

18.3%

$ 0.50

94.0%

FBHS

27-Jul

$ 0.73

$ 0.82

12.3%

$ 0.59

39.0%

GD

27-Jul

$ 2.30

$ 2.44

6.1%

$ 2.27

7.5%

GG

27-Jul

$ 0.02

$ (0.09)

-550.0%

$ 0.08

-212.5%

GIB

27-Jul

$ 0.70

$ 0.89

27.1%

$ 0.80

11.3%

GIL

27-Jul

$ 0.42

$ 0.41

-2.4%

$ 0.42

-2.4%

GLW

27-Jul

$ 0.32

$ 0.37

15.6%

$ 0.38

-2.6%

GRMN

27-Jul

$ 0.67

$ 0.87

29.9%

$ 0.72

20.8%

GT

27-Jul

$ 1.04

$ 1.16

11.5%

$ 0.84

38.1%

HES

27-Jul

$ (1.26)

$ (1.10)

-12.7%

$ (0.52)

111.5%

HLT

27-Jul

$ 0.26

$ 0.25

-3.8%

$ 0.25

0.0%

HOLX

27-Jul

$ 0.47

$ 0.51

8.5%

$ 0.41

24.4%

IMS

27-Jul

$ 0.38

$ 0.41

7.9%

$ 0.37

10.8%

IR

27-Jul

$ 1.30

$ 1.38

6.2%

$ 1.20

15.0%

KGC

27-Jul

$ 0.01

$ (0.01)

-200.0%

$ (0.01)

0.0%

KIM

27-Jul

$ 0.38

$ 0.38

0.0%

$ 0.44

-13.6%

KO

27-Jul

$ 0.58

$ 0.60

3.4%

$ 0.63

-4.8%

LH

27-Jul

$ 2.29

$ 2.31

0.9%

$ 2.09

10.5%

LRCX

27-Jul

$ 1.64

$ 1.80

9.8%

$ 1.19

51.3%

LVLT

27-Jul

$ 0.46

$ 0.53

15.2%

$ 0.42

26.2%

MAA

27-Jul

$ 1.46

$ 1.49

2.1%

$ 1.36

9.6%

MAR

27-Jul

$ 0.98

$ 1.03

5.1%

$ 0.82

25.6%

MCK

27-Jul

$ 3.35

$ 3.50

4.5%

$ 3.14

11.5%

MDLZ

27-Jul

$ 0.40

$ 0.44

10.0%

$ 0.47

-6.4%

MO

27-Jul

$ 0.80

$ 0.81

1.3%

$ 0.74

9.5%

NDAQ

27-Jul

$ 0.88

$ 0.91

3.4%

$ 0.83

9.6%

NEE

27-Jul

$ 1.58

$ 1.67

5.7%

$ 1.56

7.1%

NOC

27-Jul

$ 2.50

$ 2.85

14.0%

$ 2.47

15.4%

NOW

27-Jul

$ (0.22)

$ (0.15)

-31.8%

$ 0.14

-207.1%

NSC

27-Jul

$ 1.35

$ 1.36

0.7%

$ 1.41

-3.5%

NYCB

27-Jul

$ 0.28

$ 0.26

-7.1%

$ 0.30

-13.3%

O

27-Jul

$ 0.72

$ 0.71

-1.4%

$ 0.68

4.4%

OC

27-Jul

$ 0.85

$ 1.29

51.8%

$ 0.79

63.3%

ORLY

27-Jul

$ 2.67

$ 2.65

-0.7%

$ 2.29

15.7%

OTEX

27-Jul

$ 0.94

$ 0.89

-5.3%

$ 0.87

2.3%

PPC

27-Jul

$ 0.65

$ 0.58

-10.8%

$ 0.94

-38.3%

PSA

27-Jul

$ 2.40

$ 2.40

0.0%

$ 2.17

10.6%

PXD

27-Jul

$ (0.34)

$ (0.22)

-35.3%

$ 0.10

-320.0%

Q

27-Jul

$ 0.90

$ 0.93

3.3%

$ 0.78

19.2%

ROK

27-Jul

$ 1.46

$ 1.55

6.2%

$ 1.59

-2.5%

ROL

27-Jul

$ 0.22

$ 0.22

0.0%

$ 0.21

4.8%

SCI

27-Jul

$ 0.29

$ 0.28

-3.4%

$ 0.28

0.0%

SEIC

27-Jul

$ 0.50

$ 0.49

-2.0%

$ 0.51

-3.9%

SIX

27-Jul

$ 0.67

$ 0.64

-4.5%

$ 0.67

-4.5%

SO

27-Jul

$ 0.69

$ 0.74

7.2%

$ 0.71

4.2%

SPG

27-Jul

$ 2.62

$ 2.63

0.4%

$ 2.63

0.0%

SSNC

27-Jul

$ 0.38

$ 0.39

2.6%

$ 0.66

-40.9%

STM

27-Jul

$ 0.03

$ 0.03

0.0%

$ 0.06

-50.0%

STT

27-Jul

$ 1.26

$ 1.46

15.9%

$ 1.37

6.6%

TMK

27-Jul

$ 1.10

$ 1.11

0.9%

$ 1.05

5.7%

TMUS

27-Jul

$ 0.22

$ 0.25

13.6%

$ 0.42

-40.5%

TYL

27-Jul

$ 0.83

$ 0.87

4.8%

$ 0.65

33.8%

UNM

27-Jul

$ 0.94

$ 0.99

5.3%

$ 0.89

11.2%

VAR

27-Jul

$ 1.17

$ 1.22

4.3%

$ 1.05

16.2%

VRTX

27-Jul

$ 0.21

$ 0.24

14.3%

$ (0.54)

N/A

WEC

27-Jul

$ 0.55

$ 0.57

3.6%

$ 0.59

-3.4%

WFM

27-Jul

$ 0.37

$ 0.37

0.0%

$ 0.44

-15.9%

WFT

27-Jul

$ (0.30)

$ (0.28)

-6.7%

$ (0.10)

-120.0%

WM

27-Jul

$ 0.71

$ 0.74

4.2%

$ 0.67

10.4%

WOOF

27-Jul

$ 0.82

$ 0.87

6.1%

$ 0.70

24.3%

WYN

27-Jul

$ 1.36

$ 1.40

2.9%

$ 1.32

6.1%

XL

27-Jul

$ 0.23

$ 0.37

60.9%

$ 0.84

-56.0%

XLNX

27-Jul

$ 0.55

$ 0.61

10.9%

$ 0.48

27.1%

$ 70.48

$ 66.86

5.4%

Click to enlarge

Looking at the latest Lipper Alpha/Thomson Reuters S&P 500 Earnings Dashboard of July 29 th, I notice a few disquieting things. First up is the always popular blended earnings growth by sector with six out of ten still expected to report negative growth yielding an average of -2.6 percent in aggregate for the index component companies. The biggest concern for me is the number of companies within each sector expected to report a miss on the lowered revenue estimates. The difference between earnings and revenue expectations can be attributed primarily to company stock buyback programs and cost cutting. Neither of those efforts can last forever. That could mean that the good days will be temporary unless revenue/demand begins to pick up going forward. Six sectors are expected to have 50 percent or more of respective companies report revenue below estimates and two (Telecom and Utilities) are expected to have 100 percent miss.

I remain very cautious as earnings season is still far from over and the apparent exuberance that has driven the market to new record highs do not seem warranted. But, hey, the Fed is holding rates steady so who cares if companies make or lose money. Right?

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/we 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.