Earnings and Revenue Growth Rare

Growth

• Second-quarter total net income down 32.4% year over year
• Third quarter expected to be down 27.5% year over year
• Staples and Health Care only sectors expected to post positive growth in second quarter
• Only 31.5% of reporting companies posting earnings growth; 23.9% reported year-over-year sales growth

Surprise

• Results much stronger than feared - median surprise is 6.7%
• Positive surprises lead disappointments by 3.3:1 margin (surprise ratio)
• Surprise ratio above 8:1 for Health Care, above 4:1 for Tech, Staples and Discretionary
• Margins the cause, not revenue growth
• 71.2% of firms beat on earnings; 47.3% topped sales estimates

Full-Year Forecast

• Bottom-up estimate for S&P 500 now $60.33 in 2009 versus $60.20 last week.
• S&P 500 now expected to earn $74.68 in 2010 versus $74.42 last week
• Top down estimates $54.19 and $68.48, respectively

Revisions

• Total estimate increases outnumber cuts by almost 3:2 for 2009
• Upward revisions outnumber cuts by almost 5:4 for 2010
• Level of increases small given positive earnings surprises
• For 2009, Staples and Health Care lead; Utilities and Telecom lag
• Tech and Materials also look good for both years

Valuation

• S&P 500 P/E at 16.75x based on 2009 earnings, or earnings yield of 5.97%
• P/E of 13.53x based on 2010 earnings, or earnings yield of 7.39%
• Earnings yields attractive relative to Treasury and corporate bond yields
• Health Care has lowest P/E's of any sector

Total Net Income Growth

• Results bad absolutely, but better than expected (448 reports)
• Total net income reported $122.9 billion versus $181.8 billion last year; down 32.4%
• Only 31.4% of all reports show positive year-over-year EPS growth; 23.9% sales growth
• Only Health Care shows positive growth
• Materials and Energy expected to see massive year over year declines

The second-quarter earnings season is almost over.

It was very ugly in an absolute sense. Fewer than one-third of all companies managed to report higher earnings than they did a year ago. This was due to very weak sales, with only 24% of all firms reporting higher revenues than a year ago.

Obviously, this means that there were some firms that were able to report higher earnings even in the face of lower revenues. Given the operating leverage that is inherent to most businesses that is a pretty impressive feat. However, just how sustainable is growth based on cost cutting? Certainly not as much as growth that comes from growing revenues.

There is sort of a paradox here. For an individual company, cutting costs almost always helps the bottom line. However, those costs are either someone else's revenues or paycheck. This lowers their revenues and incomes. If everyone is cost cutting, then the revenues will be lower across the board, negating the cost cutting the individual company did. Of course, no single company can really buck the trend since then they would just have lower revenues without the lower expenses.

The total earnings reported so far (448 firms) were $122.8 billion, a decline of 32.4% from the $181.8 billion those same firms reported a year ago. However, on a sequential basis, earnings are up 11.5% from the first quarter pace. Actual earnings growth has been a pretty rare commodity with only 141 of the 448 (31.4%) reporting firms actually posting higher net income than a year ago.

Perhaps even more surprising is that only 107 or 23.9% have seen an increase in revenues. Total revenues for the 448 firms are 16.6% below last year. The median EPS growth rate is -17.1%, while those still left to report have a median expected EPS growth rate of -10.5%. If revenues are down over 16% for the S&P 500, it seems like inflation is not a serious problem at this time.

Keep in mind that median numbers are inherently equally weighted with the growth rate of a relatively small firm counting as much as that of an Exxon (XOM) or a Wal-Mart (WMT). Also changes in share count can affect EPS growth, but not total net income growth.

Surprises Scorecard:

• Positive surprises leading disappointments by 3.3:1 margin
• Median surprise is a very strong 6.65%
• All sectors but Telecom have more positive surprises than disappointments
• Materials and Consumer Discretionary are the leaders on the surprise front
• Tech, Health Care and Energy also doing better than expected

The Zacks Revisions Ratio: 2009

• Revisions ratio for full S&P 500 up to 1.46, from 1.32
• Given the level of positive surprises, the increase in revisions ratio is very small
• Five sectors in positive territory; Staples and Health Care lead
• Industrials, Utilities and Telecom continue to see estimates cut
• Ratio of firms with rising to falling mean estimates up to 1.51 from 1.26
• Total number of revisions (4-week total) up to 4,253 from 3,467 (22.7%)
• Increases up to 2,522 from 1,972 (27.9%); cuts up to 1,731 from 1,495 (18.8%)
• Total revisions activity rising rapidly, nearing seasonal peak

The sectors with the strongest surprise profiles are seeing the analysts raise their sights for 2009. This is to be expected since the second quarter is part of the full year, and the failure to raise estimates for the full year by the amount of the second quarter surprise amounts to a de facto cutting of estimates for the third or fourth quarters.

Still, the overall reaction has been relatively anemic. With more than 3x as many positive surprises than disappointments, and often by very large margins (6.7% median surprise), an under 3:2 ratio of upward revisions to estimate cuts is underwhelming. With total revisions activity close to the peak for the quarter, I do not think the data lag excuse holds anymore. Still it is nice to see more increases than cuts. The revisions ratios in Staples and Health Care are very impressive at over 3:1.

With 3x as many firms enjoying upward revisions as cuts in their mean estimates for 2009, there are many strong firms in the Health Care sector. Some that look particularly noteworthy by virtue of the number of increases and the size of the increase in the mean estimate for 2009 include Amerisource Bergen (ABC - Analyst Report), Amgen (AMGN - Analyst Report), Intuitive Surgical (ISRG - Analyst Report) and McKesson (MCK - Snapshot Report).

Staples also had its stars, the tobacco industry was smoking with Altria (MO - Analyst Report), Phillip Morris ((PM - Analyst Report) and Reynolds America (RAI - Analyst Report) all seeing significant positive activity.

The Zacks Revisions Ratio: 2010

• Revisions weaker for 2010 than 2009, but still net positive
• Revisions ratio rises to 1.24 from 1.16
• Tech and Staples showing best estimate momentum for 2010
• Telecom and Utilities getting cut.
• Ratio of rising to falling mean estimates unchanged rises to 1.18 from 0.95
• Total revisions activity near highs for the quarter
• Total number of revisions rises to 3,413 from 2,925 (23.5%)
• Estimate increases up to 2,001 from 1,572 (27.3%), cuts up to 1,612 from 1,353 (19.1%)

Earnings Shares and P/Es

• Earnings shares, including historical, based on current make up of S&P 500
• Health Care expected to take earnings crown from Energy in 2009 and keep it in 2010
• Energy's earnings share expected to plunge to 10.9% from 22.9%
• Financials' 2009 earnings share expected to rise to 11.6% from -0.8% in 2008.
• The 12-month forward S&P P/E of 14.82 equates to earnings yield of 6.75%, and is very attractive relative to the 10-year T-note yield of 3.85%, and somewhat attractive relative to 5.64% A-rated 10-year corporate.
• Health Care has the lowest P/E sector for both 2009 and 2010 with a market cap share (index weight) well below its earnings share

Data in this report, unless stated otherwise, is through the close on Friday 8/7/2009