Important Status Update On Second-Quarter Earnings

Includes: GT
by: Lou Basenese

Earlier this month, I suggested that analysts and investors alike had set the bar way too low heading into second-quarter earnings season. I also highlighted three key metrics we should be tracking as the reporting season unfolded: the earnings beat rate, the revenue beat rate, and the guidance spread.

Now that we’re halfway through the reporting season, it’s time for a checkup on these three stats -- and what it means for investors going forward. So let’s get to it.

Average, but Improving

Since aluminum giant, Alcoa (NYSE:AA) officially kicked off earnings season on July 10, another 1,000 companies or so have reported results. The bad news? The earliest figures have hardly inspired confidence. For instance, the earnings beat rate, which you’ll recall is the percentage of companies beating analysts’ expectations for profits, initially checked in at 34.6%. That’s well below the first-quarter beat rate of 59.5%.

Meanwhile, the revenue beat rate, which is the percentage of companies beating analysts’ expectations for sales, didn’t look so encouraging out of the gate, either. It initially checked in at 47.8%, compared to the first-quarter revenue beat rate of 62.7%.

So much for the bar being set too low? Well, the truth is, my initial analysis might not be so far off after all.

I say that because we still have a lot of earnings reports to dissect. And the trend for both beat rates is steadily improving. Take a look:

Mind you, this trend stands in sharp contrast to the first-quarter reporting season, which started out with a bang (an earnings beat rate above 70%) and ended with a whimper (an earnings beat rate of 59.5%).

Thankfully, the second-quarter results appear to be shaping up in exactly the opposite fashion.

From Bad to Worse

However, when it comes to the guidance spread, which is the difference between the percentage of companies raising guidance and the percentage of companies lowering guidance, there’s no way to sugarcoat the results. They’re terrible!

My colleague, Karim Rahemtulla, hinted at this yesterday when he wrote, “One American company after another is reporting that future earnings will be impacted by uncertainty in the market, thanks in part to the pending tax decision, along with the situation in Europe.”

Here’s the concrete proof:

As you can see, the current guidance spread checks in at -6.4%. That’s the lowest since late 2008. And if the reporting season ended today, it would mark the fourth consecutive quarter with a negative guidance spread.

Like I said, there’s no way to sugarcoat these numbers.

Should we panic over all the negativity, though? Absolutely not. As I’ve noted before, the doom and gloom concerning the eurozone and the economy is largely reflected in share prices already.

And here’s definitive proof of that, too:

Despite all the disappointing numbers coming out of corporations, the average company’s stock is moving up 0.7% the day it reports earnings.

That might not sound like much, but historically speaking that’s a big number. Especially when we compare it to the second quarter of last year, when companies were extremely negative as well. Back then, the average stock fell 2% on its report day.

As Bespoke says, “With the average stock gaining on the [negative] news this year, it looks like investors already priced in the weakness this time around.” Indeed.

Remember, the stock market is a forward-looking animal. Although this earnings season isn’t shaping up to be spectacular, analysts expect a strong finish to the year. In fact, the latest estimates compiled by Factset show analysts expect S&P 500 companies to report earnings growth of 11.1% in the fourth quarter of 2012.

So the strong performance for stocks on report days point to more positive results ahead as well.

Bottom line: While the latest earnings stats aren’t abysmal, they do underscore the need to choose wisely, which is to be expected at this stage of a bull market. Or more simply, as I've said multiple times before, we’re in a stock picker’s market. Accordingly, I recommend you stick to companies reporting better-than-expected earnings and raising guidance for future quarters. Like Goodyear Tire & Rubber (NYSE:GT).

Yesterday, the company reported earnings of $0.57 per share vs. estimates of $0.45, and it raised guidance for North American operations. The result? Shares rallied 8%. Even after the rally, though, the stock is still cheap, trading for less than five times forward earnings.