What Will Third Quarter Earnings Report?

by: Frederic Ruffy

Alcoa (NYSE:AA) unofficially kicks off the earnings reporting season with third quarter results due out Tuesday after the close of trading. Judging by the action in the share price lately, investors don't expect to hear much good news. The stock fell 5.9 percent Monday and is down almost 50 percent since the end of the second quarter. Ouch!

The same tale can be told over and over. Shares of many major US companies took a beating in the third quarter and the selling continues during the first four trading sessions in October. So, with the earnings-reporting season just around the corner, just how bad are these results expected to be? Let's break it down by sector and see.

As most of us know by now, the financials are still reeling and it's not a surprise that the sector will post a year-over-year decline in earnings. According to earnings estimates compiled by Standard & Poor's, aggregate operating earnings for the financial companies in the S&P 500 will total $2.80 in the third quarter, which is down more than 50 percent from $5.89 in the third quarter 2007. On the bright side, the results are a significant improvement over the loss of $1.05 seen during the second quarter.

In fact, all sectors of the market will post positive earnings and most will show an improvement from the third quarter of last year. The table below provides a breakdown. Outside of the financial companies, only two other sectors will show year over year profit declines in the third quarter, according to the most recent estimates. Total operating earnings of consumer discretionary companies (cyclicals) are expected to fall to $2.19 from $2.64 a year earlier (down 17.2 percent). Profits for the utility companies within the S&P 500 are expected to fall to $4.18 from $4.21, or .8 percent.

S&P 500 Total Operating Year-Over-Year Earnings Growth (Source: Standard & Poor's).

Energy related companies will see the most significant improvement in profits during the third quarter. Total operating earnings in the sector are estimated to increase to $15.57, or 42 percent above the $10.96 seen in the year ago period. Telecommunication, healthcare, technology, and consumer staples are among the other sectors showing positive year-over-year profit growth.

As a whole, S&P 500 companies are expected to post operating earnings of $20.83, which is down slightly from $20.87 last year. It is also well below the $24 expected a few months ago. However, analysts also expect a recovery in the fourth quarter, with financials leading the way. Total earnings are expected to increase to $23.13 in the final quarter of 2008. If so, it would represent a 53-percent improvement from the fourth quarter of 2007.

Importantly, fourth quarter estimates might be guided lower when third numbers are released. In general, companies will beat estimates for the most recent period because estimates are guided lower throughout the quarter. When the final numbers are in, results generally top estimates by 1 or 2 percent. If so, the final third quarter results, which are expected to fall .2 percent, might show year over year growth of 1 or 2 percent. However, the outlook for the fourth quarter is less certain and, if analysts are too optimistic in their expectations, those estimates could be ratcheted lower. For that reason, investors will be listening to, not just what Alcoa and others say about the third quarter, but any guidance that they might give for the fourth.