Investors are suddenly worried about earnings again, but anyone following the true nature of large cap corporate earnings trends isn't surprised at all. Although many companies are likely to disappoint this quarter, the largest companies are front and center. Disappointments from McDonald's (MCD), Microsoft (MSFT), Google (GOOG), and International business Machines (IBM) are excellent examples, but the basis for disappointment was not necessarily based on actual earnings and revenue, but instead the numbers as compared to analyst's estimates. Too often analyst estimates, distort true earnings and revenue growth, so as I do every quarter, I have peeled back the layers to look at the true health of corporate America. In doing so many revealing facts have surfaced, but one example may be representative of the largest companies in America.
With a close eye, I evaluated the earnings and revenue reported by IBM recently, and I compared that directly to past earnings and revenue. In the process of my evaluation of this third-quarter reporting season I also accounted for currency changes, so this played a significant role in my evaluation of IBM as well. The Euro has been declining against the dollar, and that has put pressure on corporate earnings, but changes in currency valuations go both ways.
At first, when we look at these third-quarter numbers we reconcile this currency dilemma, but if we roll back the clock beyond the third quarter of 2011 and look at the third quarter of 2010 something very interesting comes to light. In the third quarter of 2010 the value of the Euro was almost exactly what it was in the third quarter of 2012, so in an effort to look at an apple to apples earnings and revenue comparison for IBM I decided to compare the third-quarter results from 2010 to the third-quarter results in 2012. What I found was surprising, and may very well represent the largest companies in our economy.
In the third quarter of 2010 IBM earned $2.82 per share, net income was $3.6 billion, and revenue came in at $24.82 billion. In the third quarter of 2012 earnings-per-share increased to $3.33, but net income only grew to $3.8 billion, while revenue actually declined to $24.7 billion (see table below). Over a two-year time span, revenue at IBM contracted and dollar denominated earnings grew by only 5.56%. The comparison between 2010 and 2012 makes the difference in Euro conversion a moot point because the euro was virtually the same each time, but obviously there is more to consider.
IBM 2010 vs. 2012:
Substantial earnings per share growth of 18% also has been recorded by IBM between 2010 and 2012, and on paper that is an excellent growth rate especially for a company of its size. However, with contracting revenues and dollar denominated earnings that barely grew at all another key component was at play. Here, just like in most of the other largest companies on Wall Street, share repurchase programs play a significant role. In the case of IBM, share repurchase programs added about 10% to earnings per share over this two year time span. When added to the real dollar denominated earnings, a slight difference still exists versus reported EPS growth, but that was likely made up by cost-cutting and other endeavors.
In this evaluation process we found a company that actually contracted over a two-year time span, as real earnings grew at only a meager pace, but because the company was repurchasing shares so aggressively earnings per share looked solid. During that same time span, IBM's share price increased by about 70% and the stock now trades at about 14 times earnings. On paper, given its earnings per share growth rate this multiple looks reasonable, but it is only due to share repurchases, and if those stop that multiple is likely to tumble and reflect the true growth of that company.
Instead of growing by what appears to be 9% on average over the past two years, IBM's real dollar denominated growth rate is about 2.8%. Pay attention to the decisions of the Board of Directors here, do the same for all of the other companies on Wall Street, and if they begin to decide to stop repurchase programs we will know that the party is over. For example, if IBM stopped its share repurchase program the stock could be cut in half, or worse, without any other event having caused the decline (it would be purely based on valuation). Let's hope corporate America doesn't find another need for its money!
In the second quarter of 2012 I already proved that the Dow Jones industrial average had negative revenue growth and negative dollar denominated earnings growth, and this time I am taking that even further. With IBM as a poster child for what could be one of the worst earnings reporting seasons in recent memory, the truth is that corporate America is barely growing at all.