Earnings Trends: Battle To Stay In the Black

Earnings Scorecard and Median Growth Rates

Earnings season is off to its weakest start since the end of the last recession. Thus far median year-over-year growth is running at just 2.8%.

Granted only 11.6% or 58 of the S&P 500 firms have reported, so there is still plenty of time for things to turn around. However, after the stock market coming to believe that double-digit median year-over-year growth was something just short of a constitutional right, we seem likely to fall well short. Thus far median year-over-year growth is running at just 2.8%.

In recent years, the normal ratio of positive surprises to disappointments has run about 3.0:1. This time around it is just 1.43:1. The median surprise is holding up better at 2.2%, where in most recent quarters it ended up at 3.0% or better.

If you are looking for a silver lining, it is that the worst damage is in the Financial sector and, almost a quarter of the Financials have already reported, far more than any other sector. So far, the Financials have been responsible for two two-thirds of all the earnings disappointments.

The Consumer Discretionary sector has also been weak, showing median growth of just 2.9%, and equal number of surprises and disappointments and a 0.0% surprise. Add the disappointments in the Discretionary discretionary stocks to those in the financials and together the two sectors are responsible for more than 90% of the disappointments so far.

Also, there are three sectors which are currently shoving growth over 20%: Tech, Health Care and Materials. However, that this reflects the results of only a single company in Health Care and just three in Materials. The small sample sizes also allow the sectors to be showing massively positive median surprises of 28.0% and 12.5%, respectively.

It is highly unlikely that those levels or anything close to them will last. Looking at the expectations for those yet to report, when all reports are in Tech and Health Care should still have a strong quarter, and the Industrials should improve significantly.

[click to enlarge]

Total Net Income Growth

The median year-over-year growth discussed above is actually the good news, things look far worse on a total net income basis. 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 99.1% below year ago levels. In other words, while on a Median median basis, the reporting firms are struggling to show positive growth in earnings, on a total net income basis, it is struggling to show positive absolute earnings.

However it very much looks like a tale of two markets, with Tech doing well and Financials doing awful.

The Financials total net income is actually a net loss of $12.5 billion vs.versus profits of $25 billion a year ago. Huge losses at Citigroup (C) and Merrill Lynch (MER) were merely the most notable casualties. Based on the expectations of the yet to report firms things should improve somewhat, but still be down a staggering 92.5% 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 24.1%, while that might decline a little bit as expectations for the remaining firms stand at 21.1%, when the reported and unreported are combined, 21.9% growth is expected. That sure beats a sharp stick in the eye. The large gains at IBM (IBM) and Intel (INTC) are powering total earnings in the sector higher so far, even if Intel did come in below expectations. It certainly appears 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 14.7% when all is said and done. Note that this is a very different picture than on a median basis where Energy is expected to be near the back of the pack.

Health Care is expected to be the only other sector to break into double-digit year-over-year growth, with 12.1% when all reports are in, down from its current showing of 20.6%.

Keep in mind that we are coming off extraordinary profit years for the U.S. economy. It now looks like the worm may have turned. Since 1947, Corporate corporate Profits profits (a measure from the GDP statistics, related to but not equivalent to S&P 500 earnings) have averaged 5.95% of GDP, while over the last two years they have averaged 10.17%.

If indeed we are starting to see corporate profits return to more normal levels, the markets could be in for a world of hurt. On the other hand, the damage so far seems to be contained to the Financials and Cyclical sectors like Consumer Discretionary and Materials, based on the expectations for those yet to report.

[click to enlarge]

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 0.44, indicating well over two estimate cuts for every increase, this is down from 0.49 last week, and 0.56 two weeks ago. The total number of revisions is starting to rise. Over the last four weeks there have been 1,527 changes in estimates: 448 up and 1,079 down, up 2.3% from 1,493: 491 up and 1002 down last week. 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 over six to one6:1. In fact, the Financial sector accounts for 40% of all the estimate cuts for 2008. Among the firms which have had large numbers of cuts were, Citigroup (C), Huntington Banks (HBAN), Legg Mason (LM), Regions Financial (RF) and Wells Fargo (WFC). The Consumer Discretionary sector, with more than three cuts for each increase, accounts for another 19%. Retailers like Target (TGT), Circuit City (CC), Family Dollar (FDO) and Kohl’s (KSS) all received more than ten cuts and no increases. 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 in any be called strong with a revisions ratio of 1.30, and that’s just above the neutral zone. Two others were in the neutral zone, Health Care and Materials. In Materials the strength could be traced almost emtirely entirely to a single stock, Monsanto (MON).

The early look at 2009 revisions shows that analysts are already revising their estimates downward on balance for the year, and at almost the same rate they are doing so for 2008. The overall revisions ratio is 0.50, down sharply from 0.63 last week. As with 2008, Energy and the defensive Health Care and Staples sectors are doing relatively well, while the pictures for the Financials and Consumer Discretionary sectors look bleak. However, the total number of revisions for the whole S&P 500 for 2009 is 716: 239 up and 477 down. This is up 8.6% from 659 (254 up and 405 down) last week.

Keep in mind that the numbers for some of the individual sectors are still very light. Still, Consumer Discretionary, Financials and Utilities were all seeing cuts running at 3x increases or more. All in all, not a very encouraging outlook, even for as far out as 2009.