Earnings and Revenues Fall

Full-Year Forecast

• Bottom-up estimate for S&P 500 now $60.41 in 2009 versus $60.33 last week.
• S&P 500 now expected to earn $74.74 in 2010 versus $74.68 last week
• Top down estimates $53.84 and $67.44, respectively

Earnings Estimate Revisions

• Total estimate increases outnumber cuts by more than 3:2 for 2009
• Upward revisions outnumber cuts by almost 4:3 for 2010
• Level of increases small given positive earnings surprises
• For 2009, Consumer 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 16.62x based on 2009 earnings; equates to an earnings yield of 6.17%
• P/E of 13.43x based on 2010 earnings; an earnings yeild of 7.45%
• Earnings yields are attractive relative to Treasury and corporate bond yields
• Health Care has lowest P/Es of any sector

Total Net Income Growth

• Total net income reported $140.8 billion versus $193.7 billion last year, down 27.3%
• Only 31.0% of all reports show positive year over year EPS growth, 23.6% sales growth
• Results are absolutely bad, but better-than-expected, based on 465 reports
• Only Health Care showing positive growth

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 increasing 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 (465 firms) were $140.8 billion, a decline of 27.3% from the $193.7 billion those same firms reported a year ago. However, on a sequential basis, earnings are up 11.6% from the first quarter pace. Actual earnings growth has been a pretty rare commodity with only 144 companies (31.0%) actually posting higher net income than a year ago.

Perhaps even ore surprising is that only 110 (23.6%) have seen an increase in revenues. Total revenues are running 15.7% below last year. The median EPS growth rate is -15.9%.

One thing to keep in mind at this time of year is that we use a convention where the last full fiscal year completed is referred to as 2008, and the next one to be completed is called 2009. However, there are 23 S&P 500 firms which have June fiscal year ends, so as they report, their "2009" is becoming "2008", which can cause some of the "historical" numbers to change.

Keep in mind that medians are inherently equally weighted with the growth rate of a relatively small firm counting as much as that of an Exxon Mobil (XOM - Analyst Report) or a Wal-Mart (WMT - Snapshot Report). 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 1.57, from 1.46
• Given level of positive surprises, the increase in revisions ratio is small
• Five sectors in positive territory; Staples and Health Care lead
• Industrials, Utilities and Telecom continue to see estimates cut
• The ratio of firms with rising to falling mean estimates up to 1.55 from 1.51
• Total number of revisions (4-week total) up to 4,587 from 4,253 (7.9%)
• Increases up to 2,799 from 2,522 (11.0%); cuts up to 1,788 from 1,731 (3.3%)
• Total Revisions activity rising rapidly and is 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), a just over 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 Bristol-Myers Squibb (BMY - Analyst Report), Coventry Health Care (CVH - Analyst Report), and Mylan Labs (MYL - Analyst Report).

Consumer Staples also had its stars, the food industry was tasty with Hersey (HSC - Snapshot Report), Kellogg's (K - Analyst Report) and Kraft (KFT - Analyst Report) all seeing significant positive activity.

Sprint (S - Analyst Report) and MetroPCS (PCS - Analyst Report) were largely responsible for the weakness in the Telecom sector.

The Zacks Revisions Ratio: 2010

• Revisions weaker for 2010 than 2009, but still net positive
• Revisions ratio rises to 1.31 from 1.24
• Tech, Staples showing best estimate momentum for 2010
• Telecom and Utilities getting cut
• Ratio of rising to falling mean estimates unchanged rises to 1.28 from 1.18
• Total revisions activity near highs for the quarter
• Total number of revisions rises to 3,888 from 3,613 (7.6%)
• Estimate increases up to 2,205 from 2,001 (10.2%); cuts up to 1,683 from 1,612 (4.4%)

Earnings Share and P/Es

• Health Care expected to take earnings crown from Energy in 2009 and keep it in 2010
• Health Care has the lowest P/E sector for both 2009 and 2010; its market cap share (index weight) well below its earnings share
• 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.
• 12-month forward S&P P/E of 14.48 equates to earnings yield of 6.90% and is very attractive relative to 10-year T-note yield of 3.57%, and somewhat attractive relative to 5.52% A-rated 10-year corporate.

  Earnings Shares and P/Es
  Sector	2008%	2009%	2010%	Market Cap %	P/E 2008	P/E 2009	P/E 2010
  Technology	16.53%	16.05%	16.11%	19.01%	16.8	19.7	15.9
  Financials	-1.81%	11.70%	14.27%	14.43%	nm	20.5	13.6
  Health Care	16.28%	18.06%	15.93%	13.07%	11.8	12.0	11.0
  Cons Stpl	13.02%	14.66%	13.09%	12.55%	14.1	14.2	12.9
  Energy	23.38%	10.90%	12.94%	11.40%	7.1	17.4	11.8
  Industrials	13.62%	10.48%	9.14%	9.95%	10.7	15.8	14.6
  Cons Discr	6.52%	7.64%	8.36%	9.47%	21.3	20.6	15.2
  Utilities	4.44%	5.04%	4.40%	3.73%	12.3	12.3	11.4
  Materials	3.82%	1.66%	2.52%	3.32%	12.7	33.3	17.7
  Telecom	4.20%	3.80%	3.23%	3.06%	10.7	13.4	12.7
  S&P 500	100.00%	100.00%	100.00%	100.00%	14.6	16.6	13.4

  

  

  Data in this report, unless stated otherwise, is through the close on Friday 8/14/2009