Financial Stocks' Future Earnings Estimates: Is This a Joke?

Most of the talking heads on TV are now claiming that the financial crisis is over. Since I like to be a contrarian, an article in Friday's WSJ (03/21/08) caught my attention. Here is the key paragraph from the article:

Even if you think the credit market's and economy's problems have been totally solved, you might find the following predictions tough to swallow:

• Financial sector earnings will be up 315% in the fourth quarter of this year from last year and 27% for all of 2008.
• Overall companies in the S&P 500 index will enjoy earnings growth of 74% year over year in the fourth quarter and 17% for 2008, the biggest gain since 2004

Anyone with a toe in reality should be skeptical of such numbers which are the forecasts among Wall Street analysts, according to data compiled by S&P.

This got me thinking. I immediately pulled up estimates for Merrill Lynch (MER) and it is shocking. The following are the current estimates (courtesy of zacks.com):

Consensus EPS Earnings Trends

By the way, EPS estimates for April 2007 were -4.18, while the actual EPS was -12.57.

As I wrote this article, the following came across my monitor:

S&P revised its outlook to "negative" from "stable" on Goldman's "AA-minus" and Lehman's "A-plus" long-term credit ratings, suggesting a possible downgrade in one to two years.

I have to laugh on the possible downgrade in one to two years (too long). But I digress...coming back to Merrill, a few analysts have broken rank (on Friday Credit Suisse & Fox Pitt, both drastically cut 1Q MER estimates...but did not bring down their price targets a lot). Of the 12 analysts ratings the following is the breakdown:

• 2 have strong buy (real geniuses out here)
• 1 buy
• 8 hold
• 1 strong sell

So the question is, can Merrill hit 4.14 for 2008? Even though this number has come from 6.95 sixty days ago, there is absolutely no way they can hit this number with significant write downs yet to occur. I am using Merrill just as an example. The same is true for the estimates for other financial companies. As such, when the analysts (I am using the term loosely...I am not sure what they are analyzing) start additional trimming of estimates leading to target price reduction, the reaction of the herd mentality would be get very nervous and start further dumping of these stocks. Let us not forget that write-downs of CDOs is only half way over and many of these assets are extremely illiquid. True value of these assets, even now, is very tough to ascertain. It is going to be one helluva ride for the rest of the year.

Disclosure - Long SKF (ultrashort Financials)..opened new positions on Friday. Will be going short on GS, MER, MS and LEH this week.

Comments

[SwampCotton:]

I am also long on SKF from last week and short both MER and GS.

The Economist has about ten pages on the Wall Street situation in their lastest issue of March 22nd through March 28th.

I quote from page 82:

"The outlook remains bleak, however. By one estimate, banks will writeoff a further $50 billion of degraded inventory this quarter. If they are more tightly regulated, they could have less scope to make profits. Using tangible book value as a yardstick, Meredith Whitney of Oppenheimer concludes that the financial shares are due a further fall of up to 5o%. With house prices still falling, credit deterioration spreading and derivatives markets deeply unsettled, is anyone willing to bet that Bear Stearns is the last of the $2 sales?"

I believe the bear market has a tight grip on the financials.

2008 Mar 24 08:15 AM

[pickaroonwyo:]

Now if the Fed loans them cheap money and buys their sketchy holdings, it should be a "happily ever after".

2008 Mar 24 08:56 AM

[phdinsuntan...:]

you can be long on these stocks in US$ but not in British Pounds or Euros, got it? yeah! Willy Coyote still playing ACME toys, year of the rat is for bears!

2008 Mar 24 02:05 PM

[Kingoil08:]

Morgan stanely has not down graded thier MBS by any reasonable standard. MS' interst expense for 07 came out to 67% of their total revenue? Is this correct? And they rallied so hard last week...I bought the April 45 puts at the end of the Friday rally. The only thing keeping them afloat is their trading. I'm sure they sell into their own rallies...and so will I!

2008 Mar 24 03:19 PM

[drmalaka:]

Anyone who believes the crap coming out of the banks is a fool. Have these criminals not stolen enough money from the public?

I have no sympathy for anyone who is going to get killed buying financials or home builders in this market. Listening to these confirmed liars and investing on their lies is idiotic.

Only two things come out of bankers mouths when they speak: bad news or lies. If it is not bad news then you know what it is.

2008 Mar 24 05:55 PM

[john1:]

If you don't believe, the trrrists have won!!!

2008 Mar 24 07:25 PM

[MikeM:]

In my view, most people berating the big money center banks don't know what they're talking about. There's a big difference between writing down the value of an asset (along with the hit on earnings) and actually having the asset not be eventually worth more than that. The big banks are taking big hits on these assets just in case the worst happens. But the worst is not likely. So longer term, some of these write offs will be write ups and add back to earnings.

Frankly I don't understand the hate for big business that some people have. The people in those companies why are so easily labeled liars, thieves, and worse. Fact is, they are doing a great service lending money to farmers to buy equipment, supplies, and plant crops, for people to buy houses, etc. You sit next to them in church on sunday.

I am not a banker. However, I have received a few loans over my life that I do appreciate getting. They made things possible. I'm tempted to print up a rather contrarian bumper sticker that would say: "Kiss Your Loan Officer".

2008 Mar 24 09:39 PM

[Kingoil08:]

MikeM...it is not the job of the banks to under score their write downs by using inappropriate bench marks to adjust the value of the level 3 assets. It is their duty to report accurately to their share holders, or as accurately as possible in this case. To do what these guys do, I would have to spend many days in church trying to clean my soul.

2008 Mar 25 12:23 PM

[Subprime Bo...:]

The investment banks will be fine, forecasts on their earnings are reasonable considering the love and caring they're getting from the central bank. Let's face it, if any of the big i-banks were allowed to go bust the global financial system would collapse, sending the world economy into depression. The worst that will happen is MER or UBS will be gobbled up by GS.

The real concern in this cycle is commercial banking and credit cards; the market doesn't full appreciate the very scary situation they're in. Take Capital One (COF) for example. They're trading 25% above target despite heavy delinquency rates, charge-offs, rising unemployment, etc. Barron's sums up their situation nicely:

"The problem for Capital One, though: the Fed hasn't
done anything to change the bank's fundamentals. The central bank has been remedying the problems of broker/dealers and the holders of deteriorating mortgage products, not credit-card lenders. Instead, the problems associated with that part of the banking system - the
reticence of the strapped consumer, as well as the rise in delinquiencies - haven't been redressed. Friedman Billings Ramsey said Tuesday that the run has left the stock over-valued."

2008 Mar 25 10:04 PM

[Stephen Fra...:]

it's not hard to beat last year's numbers (especially q4) by a bajillion percent... considering the losses posted at the end of last year.

2008 Mar 26 02:45 AM