Earnings Trends: Mixed Early Returns

Earnings Scorecard and Median Growth Rates

The fourth quarter earnings season is off to a mixed start. So far, positive surprises are outnumbering disappointments by just over 2:1 - a little bit behind the "normal" 3:1 margin. The median surprise is a healthy 3.36%. The median year-over-year growth rate is 6.98%, which is well behind the double-digit median growth rates we have been accustom to for the last five years.

Keep in mind that it is still very early and the current sample of reports is hardly representative. In fact, four sectors have yet to have any firms report.

Among those that do have reports in, Tech looks terrific with median year-over-year growth of 29.7%. That number should come down significantly as the remaining firms have a median expected growth rate of 20.0%. Still, that sort of growth is better than a sharp stick in the eye, and should be good enough for silver in the median year-over-year growth race.

Materials looks like a dramatic winner so far, but that is based on a sample of one, Monsanto (MON). When the rest of the sector reports, analysts are expecting median year-over-year gains of 8.9%.

On the other hand, the Financials would probably prefer the sharp stick in the eye. The median earnings growth is -141.5%, indicating that more than half the reporting firms have moved from positive earnings in a year ago to a loss this year. That number should get better as reporting season continues, but is still likely to be anemic at best when all is said and done. The median expected year-over-year growth for the remaining firms in the sector is just 5.0%, and the estimates are falling fast.

Energy should be the top performing sector on a median growth rate basis with 24.4% growth anticipated. Tech and Industrials are predicted to take the silver and bronze with growth rates of 20.0% and 15.5%, respectively.

Total Net Income Growth

On a total net income basis, so far the fourth quarter can be summed up in a single word: UGLY. Total net income reported so far is 59.5% below year ago levels. However it very much looks like a tale of two markets, with Tech doing well and Financials doing awful.

Total net income for the Financials is actually a net loss versus profits a year ago and based on the expectations of the yet to report firms things should improve somewhat, but still be down a staggering 66.9% when all is said and done.

Telecom will lead the pack but that is artificially boosted by the AT&T/Bell South (T) merger a year ago.

Tech so far is up just 8.2%, but the picture should improve once the rest of the firms come in to 19.4% year-over-year growth. That sure beats a sharp stick in the eye. The recent pre-announcement by IBM of better than expected earnings certainly seems to confirm that Tech will be one of the bright spots for the quarter.

Energy, riding oil prices that remain well over $90 a barrel has yet to have any firms report, but should be up 15.6% when all is said and done. Health Care is expected to be the only other sector to break into double digit year-over-year growth. On the other hand, when all the firms report, Financials will stand alone actually being down year over year, but four other sectors, Consumer Discretionary, Materials, Consumer Staples and Industrials are expected to have year-over-year growth that is south of 3.0%. Considering currency translation effects and strong demand overseas, that implies that domestic earnings for those sectors will be down year over year.

The Zacks Revisions Ratio

To help gauge the direction of the market, we take note of what analysts are thinking. By tallying their EPS changes, we can determine our revisions ratio. This ratio simply divides the total number of positive estimate revisions by the total number of estimate cuts. Thus, a high ratio is a bullish indicator and a low ratio is bearish. For the S&P 500 as a whole, a number below 0.80 or above 1.25 is generally significant. For individual sectors the distance from 1.0 should be greater for the numbers to be significant.

The revisions ratio for 2008 is 0.49, indicating over two estimate cuts for every increase, this is down from 0.56 last week. The total number of revisions over the last four weeks was 1,493: 491 up and 1002 down. As earnings season gets into full swing over the next few weeks, the totals will climb significantly from current levels.

By far the sector that is faring the worst is the Financials where cuts out number increases by almost 7:1. In fact, the Financial sector accounts for 40% of all the estimate cuts for 2008. Regional banks like Key Bank (KEY), Fifth Third (FITB) and National City (NCC) were slammed with double-digit numbers of analysts cutting and no increases.

The Consumer Discretionary sector accounts for another 19%. Retailers like Target (TGT) Circuit City (CC) and Best Buy (BBY) were particularly hard hit.

Put another way, the revisions ratio for the rest of the S&P 500 is 0.95, which is very much in the neutral range (0.71 if just the Financials are excluded). On the other hand, Energy was the only sector that could truly be called strong with a revisions ratio of 1.78.

Three others were in the neutral zone, Tech, Health Care and Staples. Note that Health Care and Staples are two of the sectors that are least sensitive to overall economic growth. Tech is doing well on the strength of international operations for the most part. Energy was also the only sector where more firms saw rising mean estimates than falling estimates.

The early look at 2009 revisions shows that analysts are already revising their estimates downward on balance for the year, although not at the same rate they are doing so for 2008. The overall revisions ratio is 0.63, indicating more than three cuts for every estimate increase. As with 2008, Energy and the defensive Health Care and Staples sectors are doing well, while the picture for the Financials and Consumer Discretionary sectors looks bleak. However, the total number of revisions for the whole S&P 500 for 2009 is just 659 (254 up and 405 down) and the numbers for some of the individual sectors are very light. If this holds up, the go heavy on Energy and light on Financials play that was so profitable in 2007 looks like it will work again in 2008.