Earnings Trends: Analysts Cutting Full-Year Estimates

Fourth-quarter median year-over-year growth is expected to fall to 8.0%, and total net income growth is expected to be significantly below that.

These are median numbers, so keep in mind what a median measures. It means that half the firms reported growth of over 8.0% and half below 8.0%. It means that half the firms reported growth of over 11.5% and half below 11.5%. It does not matter if it is 11.5% or 111.5%; it still means half above and half below. The measure does also not distinguish between a mega firm like ExxonMobil (XOM) and a firm just big enough to make it into the S&P 500. A doubling of small firms’ earnings would be a rounding error for XOM. Median is, however, a good measure of what a "normal" firm did.

Average earnings growth can be influenced significantly by outliers. For instance, if one firm reports massive EPS growth because it moved from a penny to a dime, the average for the entire sector gets skewed to the upside - even if a whole bunch of competitive firms saw earnings fall by 20%.

The first table also tracks EPS, and as such it has been bolstered by share repurchase. A good part of the reason for the strong showing was the strength seen overseas, both in the form of high unit demand from booming emerging economies and the currency translation effects of the plunging dollar.

There should be major differences among the sectors in terms of median growth in the quarter, with half the sectors posting double-digit growth, and four not even reaching the 4% level, which given headline inflation running at over that level would indicate a decline in real terms.

In general the strong EPS growth in the third quarter was not accompanied by strong guidance for the fourth quarter. The median expected year-over-year growth is only 8.0%. We have seen low expectations for the coming quarter before at this stage often before, only to see more positive than negative surprises when the results finally come in. Managements have learned to under promise and over deliver. However, the third quarter was a time of very strong economic growth. It is unlikely that the fourth quarter will be as strong.

Looking at the expectations by sector for the quarter, Energy is expected to bounce back from its poor showing in the third quarter and post 19.0% growth, far outdistancing the expected bronze and silver medalists, Industrials and Tech, at 14.0 and 14.3% respectively. Materials are expected to post negative growth rates (down 3.3% year/year) and three other sectors are not expected to get over the 5.0% mark, Telecom, Financials and Consumer Discretionary.

We have, of course, seen predictions of a slow down in the current quarter many times before, only to see positive surprises swamp disappointments and result in double-digit year-over-year gains in median EPS. Could it happen again? Sure.

Total Net Income Growth

Total net income, even before non-recurring items, is expected to fall almost 1% in the fourth quarter. Since earnings are a nominal item, real inflation adjusted growth was even lower.

The key reason for the expected negative earnings growth for the fourth quarter is a 33.8% expected plunge in Financial sector earnings. By and large, the insurance stocks should do okay, while the banks will be battered. We will get the first indications for the sector this week with three major investment bankers reporting.

The Energy sector should show a nice rebound from its weak showing in the third quarter with 12.2% growth this quarter. Consumer Discretionary sector should also see a nice rebound, although given the estimate cuts for the year, disappointments there are a distinct possibility. Telecom, artificially helped by the AT&T (T)/Bell South merger should show another strong quarter with 29.6% growth. The cyclical Materials and Industrial sectors are expected to post weak but positive growth of 3.0% and 5.9% respectively.

Written by Dirk Van Dijk

Comments

[A Christian:]

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2007 Dec 27 07:46 AM

[stockdude:]

Interesting analysis. So it looks like Consumer Discretionary names should have the biggest swing over the next year.

2007 Dec 31 10:55 AM