Earnings Trends: Okay Median EPS Growth

Almost two-thirds of earnings results are in, and on a median year-over-year growth basis, things are not looking to bad.

Overall growth is inching up and we might even have a shot at double-digit growth. As it stands now, we are just under 9.0%, and the median expected growth of the remaining firms is almost 13%.

Keep in mind what the median measures, however. For example, if a firm reports EPS growth of 10%, it will have exactly the same effect on the median as if it reports growth of 100%. Median also implicitly counts the results from a mega cap firm like Exxon (XOM) or Citigroup (C) the same as the results of Range Resources (RRC) or Hudson City Bancorp (HCBK). Also, stock repurchase programs lifts EPS growth through the shrinking of the denominator.

Still given the pervasive (and well justified) economic pessimism, the fact that the "normal" firm in the S&P 500 is growing its EPS at almost double-digit rates is quite comforting.

On the surprise front, things are not all that bad either, although not as strong as we have seen in past quarters. Positive surprises are leading disappointments by a ratio of 2.26:1 (3:1 or better has been normal in recent years) and the median surprise is a relatively healthy 2.56% (over 3% has been normal). Further, the disappointments have been highly concentrated in the Financial and Consumer Discretionary sectors (and to a lesser extent in Energy). Together those sectors account for almost two-thirds of all disappointments, even though they account for just over one-third of all firms that have reported.

Several sectors have reported extremely strong surprise ratios, including Utilities (14:1), Industrials (17:1) and Tech (7.8:1).

In terms of growth, four sectors - Utilities, Energy, Health Care and Tech - are seeing EPS growth of over 15%. Only the Financials are in negative territory, although the Consumer Discretionary and Materials results are anemic at less than 3.0%.

In terms of likely movement in the standings before all is finished, Telecom has the best potential to improve given both how few of its members have reported so far and the current expectations for those that are yet to report. Utilities might move down a spot, but should remain on the medal stand. Financials might improve a bit, but they are unlikely to shed the loser crown. Energy and Tech both have room to move up.

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Total Net Income Growth

The overall story when it comes to total net income growth is very different than that of the median growth rate. The total net income of the 319 firms that have already reported is a stunning 23.6% below a year ago.

Telecom, artificially boosted by the AT&T/Bell South (T) merger sits atop the standings with 45.6% growth. That number sill come down, barring a huge upset (think Ron Paul winning the Ohio primary) when the remaining sever firms report. However, based on the combination of already reported and forecasted results, it should still be the top performing sector.

Tech should hold on to its silver medal position, currently coming in at 29.9%, but expected to drop to 27.7% when all is said and done. Currently Health Care narrowly holds the bronze over Energy, with growth of 17.7% and 17.5%, respectively.

When the final results are in Energy should hold the third place finish by a fairly comfortable margin, with 22.2% growth expected vs. 17.8% growth from Health Care. Still 17.8% growth in total net income is nothing for Health Care investors to complain about.

Despite the valiant efforts by these sectors, they can not overcome the down right ugly results of the Financial sector to power the overall index into positive growth. Financials, normally far and away the largest source of net income in the S&P 500 are currently losing money in total. There is still a chance that they could climb out of the sea of red ink and onto the beaches of break even, but they will remain far from the mountains of actual higher profits.

The cyclical Consumer Discretionary and Materials sectors are so far also reporting lower total earnings than a year ago. It is worth noting that looking forward to the first quarter all three of the down sectors this quarter are expected to be down again. There is also expected to be a sharp decline in the total net income growth rate for most of the sectors that are faring well so far this quarter.

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Estimate Revisions

We also note that the strong positive surprises outside of Financials and Consumer Discretionary is not translating into upwards estimate revisions for 2008. Estimate cuts are still running 2:1 over estimate increases. While the sectors with overwhelmingly positive surprise ratios are faring better than the others, with the exception of Health Care, they are still getting cut more than increased, but not by the lopsided margins that the more disappointing sectors are being cut.

For all of 2008, currently the Financials are expected to see strong growth as they bounce back from the disaster that was 2007, the expectations are clearly coming downwards. It probably makes more sense to look at the two year growth rate from 2006 to 2008. On that basis, Financial earnings are currently expected to be 5.4% lower in 2008 than in 2006. Given the pace of estimate cuts, that seems extremely optimistic to me.