With the majority of last quarter's earnings reports now posted, it may be worth investing a little time to study - and we mean really study - just how they came out. Why? They hold some important clues about the future.
It's no big secret that earnings last quarter were better than earnings from the same quarter a year ago, as well as better than expected for this year. What's not as readily realized, however, is which sectors improved the most, which sectors doled out the biggest surprises, and which sectors fell short of all expectations.
We'll get to all of that. First though, let's start with the basics.
With nearly all of the stocks in the S&P 500 having reported their numbers, 72% have topped analysts' estimates, while 21% fell short of forecasts. Both were close to records, pointing to a widening gap between strong and weak results.
As for a raw number, the S&P 500 is going to earn about $16.77 per share for the quarter on an operating basis, and is going to earn about $15.51 on a GAAP basis. Both are slight adjustments to the numbers we posted last week. The respective annualized P/E ratios roll out to 16.6 and 18.0.
Overall, it's definitely a step in the right direction. On the other hand, with massive cost-cutting initiatives on the table, is it possible that corporate America is simply shrinking its way to success? Three quarters ago, the answer would have been yes. Now, however, we can say the growth is real.... even if modest.
Total revenue was up 4.9% last quarter. Granted, comparing Q4-2009 to Q4-2008 is a ridiculously easy comp to top, but still, it shows progress.
Lots of sectors you'd expect to do better did indeed do better. Information technology stocks grew earnings by about 58%, and basic materials earnings grew by about 78% last quarter. Revenue was up 8.8% and down 0.1%, respectively. Both areas posted upside surprises, fueled by economic growth and/or inflation, and/or easy comparables.
The biggest turnaround story, however, came from the consumer discretionary sector. The sector's earnings rebounded 110% last quarter... more than twice the improvement expected. Sales grew by 4.0%.
Given the combination of revenue growth and earnings growth, fourth quarter's results bode very well for the tech and consumer discretionary sectors. And, both are arenas that stand to do well at this stage of a recovery. We expect more positive surprises going forward (which is saying something, since 89% of technology stocks and 94% of cyclical stocks posted upside surprises for the prior quarter).
The fact that basic materials stocks saw declining revenue despite stronger commodity prices, however, is a major red flag. Yes, higher earnings could mean better management of cash flow, but very poor results a year ago makes big improvements easier to muster now. Between inflation (or lack thereof), ever-changing expectations, excessive speculation, and so-so performance compared to other sectors last quarter, the basic materials sector may simply be overrated right now (more on that below).
Stunningly, some sectors managed to do worse in the fourth quarter of 2009 than they did in the fourth quarter of 2008.... earnings-wise and revenue-wise.
Telecom was one of the biggest losers, shrinking income by 30% despite a 3.9% improvement in revenue. It's a testament to higher costs and mismanagement of spending and internal investments. That said, we've also observed that the large cap names in the group are the ones doing most of the back-sliding. Many of the smaller names in the telecom sector (wireless and fixed line) are actually doing well. So, don't generalize too much.
Energy stocks also saw earnings shrink by about 30%, with only a 1.7% increase in revenue. Neither are encouraging. If anything, both should have been strong in comparison, as gasoline usage and oil prices should have been stronger compared to the last quarter of 2008.
What gives? One possibility is that the oil companies really were gouging consumers late in 2008, and -frankly - they now realize they can't continue doing it and reaping the excessive reward. Another possibility may simply be that these companies just aren't doing as well as they were, as the recovery has been soft thus far.
Either way, until it's crystal clear the recession is over, the energy sector is apt to fall short of expectations going forward in 2010.
And finally, the industrials saw income shrink about 8% on a 4% dip in sales. This certainly doesn't point to 'recovery spending' levels from business just yet. However, the tepid declines don't scream 'stay away' either. Just choose carefully.
And where do the financial stocks rank in the 'improvement' pile? There's no answer, because it's impossible to measure meaningful 'improvement' when the sector was a net loser for the comparable quarter a year earlier. Just for the record though, the sector's revenue was up 23% last quarter, and earnings did turn positive.
While the sector as a whole is looking better, we still see a few rebounding companies carrying more (ok,most) of the group's weight than they can carry indefinitely. In fact, when you start to break the sector down into its individual industries, the gap between the winners and lowers is widening.
As for what this means to investors, there is opportunity within the sector, but the sector itself is not an opportunity as a whole right now.
With the exception of the basic materials sector and the special care needed with the financial stocks, we're taking all the trends we discussed above at their face value. Any sector we didn't mention above could be considered neutral from our viewpoint.
That said, there is one dimension worth adding to the analysis.
While improving earnings and revenues are important, if a stock is too expensive then it's still too expensive. To that end, on the nearby table you'll find 2009's operating P/E ratios by sector (which are almost entirely complete), and 2010's estimates (which have been updated as of last quarter's results).
Much of the time one would expect this P/E analysis to perhaps trump another form of analysis. In this case though, the valuations - now and later - pretty much support our outlook described above.
For instance, though the tech sector did very well last quarter, the current P/E of 19.4 is very affordable by technology stock standards, and the projected P/E of 14.7 is very plausible just because these companies are close to those results now.
Conversely, the fact that energy stocks and basic materials stocks did so poorly last quarter - and last year - forces investors to question whether or not the forecasted P/E ratios are plausible - in the shadow of rich P/E levels for the last twelve months - for those groups. Can either of these groups really almost double earnings in 2010 as suggested? Based on what we saw last quarter, probably not, meaning these stocks are a recipe for disappointment.
Things can and do change as time wears on, but we now have enough data to make a fair assessment of different sectors' health. In short, the men are being separated from the boys. That's great news for stock-pickers, and bad news for certain sectors.