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Earnings Trends

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Key Points:

Growth

  • Second-quarter total net income down 31.0% year-over-year
  • Third quarter expected to be down 22.9% year-over-year
  • Fourth quarter to more than double a year ago, but it is all in the Financials
  • Health Care only sector to post positive growth in second quarter
  • Only 32.4% of companies posted earnings growth last quarter; 25.0% post sales growth year-over-year

Surprise

  • Results much stronger than feared; median surprise was 6.7%
  • Positive surprises lead disappointments by 3.4:1 margin (surprise ratio)
  • Surprise ratio above 8:1 for Health Care and above 4:1 for Tech, Staples and Discretionary
  • Margins the cause, not revenue growth
  • 71.2% of firms beat on earnings; 45.9% beat sales estimates

Levels

  • Bottom-up estimate for S&P 500 now $60.97 in 2009 versus $60.60 last week.
  • S&P 500 now expected to earn $75.09 in 2010 versus $74.90 last week
  • Top down estimates $52.94 and $67.09, respectively

Revisions

  • Total estimate increases outnumber cuts by than 7:4 for 2009
  • Upward revisions outnumber cuts by more than 3:2 for 2010
  • Revisions ratios for both years have risen consistently through earnings season
  • 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 16.9x based on 2009 Earnings, or an earnings yield of 5.91%
  • P/E of 13.73x based on 2010 earnings, or an earnings yield of 7.28%
  • Earnings yields attractive relative to Treasury and corporate bond yields
  • Health Care has lowest P/Es of any sector

Growth

  • Total Net Income falls 31% year over year in 2nd Quarter, 3rd quarter expected to decline 22.9%
  • Median EPS declines by 17.4% in 2nd Quarter, 16.2% decline expected in 3rd Quarter
  • Explosive 131.6% growth in Total income expected in 4th Quarter, but it is all about last year
  • Financials responsible for ALL of the expected year over year growth in the fourth quarter
  • Materials and Energy see massive year over year declines in 2nd quarter and expected in the 3rd Quarter.

The second-quarter earnings season is 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 25% of all firms reporting higher revenues.

It is time now to turn our attention to the third quarter and take a first peak at what to expect from the fourth quarter. By and large, the third quarter should be pretty much a repeat of the second quarter in terms of who the winners and loser are with a few major exceptions.

The most notable of these are the Financials, where total net income is expected to more than double in the third quarter instead of almost falling in half like they did in the second quarter. However, that is all about last year, not this year. On a sequential basis, the sector's earnings will only be up by 6.3%. That is nice, but hardly earth shattering.

The story of the year-over-year growth rates being more about a year ago than this year is even more extreme in the fourth quarter. For the S&P 500 as a whole, the growth is expected to be 131.6%. To be more specific, the total net income expected is $149.7 billion in the fourth quarter of 2009 versus a total net income of just $71.1 billion in the fourth quarter of 2008. However, in the dark days of last year, the Financial sector lost a staggering $63.2 billion (with AIG alone responsible for $37 billion).

The swing in the Financials accounts for over 99% of the total swing in the S&P 500 earnings expected for the fourth quarter. In other words if you strip out the special case of the Financials, earnings should be just about flat on a year over year basis. While that is a big improvement from the 30% declines we have been seeing, it is a far cry from the 131.6% improvement before you account for the Financials' swing.

Total Net Income Growth1 (%)
Sector 4Q'09 E 3Q'09 E 2Q'09 A 1Q'09 A 2008 A 2009 E 2010 E
Financials - to + 121.05% -49.71% -41.71% + to - - to + 48.93%
Cons. Disc. 72.70% 15.67% -13.25% -46.27% -27.77% 4.97% 33.54%
Health Care -3.04% -3.21% 3.94% 1.82% 11.71% -2.50% 9.16%
Utilities 4.51% -3.86% -5.37% -2.52% 1.75% -2.49% 8.24%
Cons. Stap. 7.99% -4.70% -2.98% -3.89% 0.67% -0.58% 10.33%
Technology 19.64% -18.31% -15.49% -26.91% -13.36% -61.76% 87.23%
Telecom -15.92% -19.53% -27.32% -16.72% -5.21% -20.33% 5.01%
Industrials -19.67% -38.06% -31.90% -35.95% 0.33% -32.23% 7.81%
Energy -30.14% -64.68% -66.55% -58.85% 21.87% -58.83% 46.81%
Materials 191.10% -70.80% -66.65% -78.30% 8.15% -14.14% 24.24%
S&P 131.64% -22.93% -30.99% -31.64% -20.18% -11.68% 23.39%

Total $ and Shares of Total ($)
Sector Total 4Q09 E Total 3Q 09 E Total 2Q 09 A Total 1Q 09 A Share 2Q 09 A Share 3Q 09 E Share 2Q 09 A Share 1Q 09 A
Cons. Disc. $13,158 $11,309 $11,539 $6,989 8.49% 8.19% 8.49% 5.68%
Cons. Stap. $21,858 $20,513 $20,096 $17,679 14.78% 14.85% 14.78% 14.36%
Energy $17,408 $15,891 $13,328 $13,641 9.80% 11.45% 9.80% 11.08%
Financials $16,219 $14,564 $13,705 $13,101 10.08% 10.54% 10.08% 10.64%
Health Care $24,479 $24,435 $25,566 $25,327 18.80% 17.69% 18.80% 20.58%
Industrials $15,131 $13,756 $15,797 $13,163 11.62% 9.96% 11.62% 10.70%
Technology $27,905 $21,927 $21,518 $18,338 15.83% 15.87% 15.83% 14.90%
Materials $2,657 $2,020 $2,951 $1,752 2.17% 1.46% 2.17% 1.42%
Telecom $5,209 $5,217 $5,292 $5,710 3.89% 3.78% 3.89% 4.64%
Utilities $5,658 $8,603 $6,177 $7,981 4.54% 6.23% 4.54% 6.00%
S&P $149,684 $138,162 $135,969 $123,080 100.00% 100.00% 100.00% 100.00%

Median EPS Growth Rates %
Sector 2Q '09 (A) 3Q '09 (E) 4Q '09 (E) 2008 (A) 2009 (E) 2010 (E)
Health Care 9.72% 3.31% 4.28% 12.40% 7.60% 10.20%
Cons. Stap. 2.83% 0.38% 7.08% 4.40% 6.40% 9.40%
Utilities -2.86% -2.60% -6.49% 3.20% -1.60% 7.60%
Telecom -18.52% -7.48% -7.85% 2.00% -4.20% 4.50%
Cons Disc -19.75% -16.37% -2.49% -4.90% -10.80% 13.60%
Tech -18.78% -20.23% -6.67% -5.30% -26.55% 18.65%
Materials -33.34% -21.39% 0.00% 0.50% -9.80% 17.00%
Industrials -25.13% -24.83% -19.15% 12.15% -20.25% 11.95%
Financials -32.82% -26.93% -16.14% -14.15% -24.45% 21.45%
Energy -65.12% -65.65% -28.24% 23.10% -57.45% 19.50%
S&P 500 -17.37% -16.17% -6.26% 2.80% -8.90% 7.30%

Surprises Scorecard:

  • Positive surprises leading disappointments by 3.4:1 margin
  • The median surprise is a very strong 6.75%
  • 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 are also doing better than expected
  • Financials responsible for more than 1 in 4 disappointments

Scorecard
Sector %
Reported
Median %
Surprise
# Pos
Surprise
# Neg
Surprise
# Match
Materials 100.00% 14.37% 20 5 3
Cons. Disc. 100.00% 10.81% 60 16 5
Tech 100.00% 9.18% 53 10 10
Energy 100.00% 7.13% 27 11 2
Cons. Stap. 100.00% 6.17% 31 5 2
Industrial 100.00% 6.09% 43 9 5
Utilities 100.00% 5.96% 22 12 2
Healthcare 100.00% 5.72% 44 5 3
Financial 100.00% 1.03% 46 26 4
Telecom 100.00% -4.35% 3 5 1
S&P 500 97.20% 6.75% 349 103 38

The Zacks Revisions Ratio: 2009

  • Revisions ratio for full S&P 500 up to 1.75, from 1.68
  • Revisions ratio up throughout earnings season
  • Six 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 1.33 from 1.55
  • Total number of revisions (4-week total) down to 3,015 from 4,371 (-31.0%)
  • Increases down to 1,917 from 2,740 (-30.0%); cuts fall to 1,098 from 1,631 (-32.7%)
  • Total Revisions activity passed seasonal peak, falling rapidly

The long string of improvements in the total revisions ratio for 2009 is impressive, as is the overall level of 1.75, indicating 7 estimate increases for every 4 cuts. Only one sector is in negative territory and only three are in neutral. Staples and Health Care continue to lead the pack, with more than 4 and 3 increases per cut, respectively. Tech and Discretionary are also at very solid levels.

Telecom had three very weak members, Sprint (S), MetroPCS (PCS) and Frontier (FTR - Analyst Report), causing the big drop in the average estimate for the sector. Applied Materials (AMAT - Analyst Report) and Motorola (MOT) were among the leaders in the Tech sector.

Sector Avg. 4wk EPS
Change (FY1)
Revisions
Ratio
Firms With
FY1 EPS
Increase
Firms With
FY1 EPS
Decrease
Consumer Staple 3.73% 4.11 24 10
Health Care 0.26% 3.18 34 16
Technology 5.90% 2.85 44 22
Consumer Disc 1.56% 2.24 43 29
Materials -0.61% 1.86 16 10
Financial Services 0.21% 1.44 38 38
Energy 3.88% 1.22 24 16
Industrials 0.33% 0.88 24 32
Telecom -8.27% 0.82 4 5
Utilities -0.83% 0.57 14 21
S&P 500 1.61% 1.75 265 199

The Zacks Revisions Ratio: 2010

  • Revisions weaker for 2010 than 2009, but still net positive
  • Revisions ratio rises to 1.52 from 1.38
  • Tech and Staples showing best estimate momentum for 2010
  • Telecom and Utilities getting cut
  • Ratio of rising to falling mean estimates declines to 1.28 from 1.43
  • Total revisions activity passed highs for the quarter
  • Total number of revisions falls to 2,566 from 3,674 (-5.5%)
  • Estimate increases fall to 1,548 from 2,133 (-27.4%), cuts down to 1.018 from 1,541 (-33.9%)

Sector Avg. 4wk EPS
Change (FY2)
Revisions
Ratio
Firms With
FY2 EPS
Increase
Firms With
FY2 EPS
Decrease
Consumer Staples 1.40% 3.63 22 12
Technology 4.17% 2.82 44 17
Consumer Discr 1.47% 2.37 45 27
Health Care -0.23% 2.12 27 22
Materials -1.09% 1.55 16 10
Energy 1.05% 1.25 23 17
Financial Services -0.24% 1.12 36 37
Industrials -0.75% 0.82 24 30
Telecom -14.52% 0.45 2 7
Utilities -1.03% 0.44 13 18
S&P 500 0.51% 1.52 252 197

Valuation - Earnings Shares and P/Es

  • Health Care to take earnings crown from Energy in 2009, but yield to Tech 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.
  • Financials' back to having the second highest weight in the index
  • 12-month forward S&P P/E of 15.0 equates to earnings yield of 6.67%, which is very attractive relative to 10-year T-note yield of 3.57%, and somewhat attractive relative to 5.32% A-rated 10-year corporate.
  • Health Care the lowest P/E sector for both 2009 and 2010; it's market cap share (index weight) well below its earnings share

Earnings Shares and P/Es
Sector 2008% 2009% 2010% Market
Cap %
P/E
2008
P/E
2009
P/E
2010
Technology 16.52% 16.00% 16.17% 19.01% 18.7 20.1 16.2
Financials -1.81% 11.88% 14.24% 14.53% nm 20.7 14.0
Health Care 16.27% 17.90% 15.85% 13.09% 12.5 12.4 11.3
Cons Staples 13.00% 14.62% 13.03% 12.37% 14.6 14.3 13.0
Energy 23.36% 10.87% 12.96% 11.46% 7.6 17.8 12.2
Industrials 13.60% 9.94% 8.97% 9.85% 10.9 16.8 15.1
Cons Discr 6.51% 7.93% 8.55% 9.65% 20.0 20.6 15.5
Utilities 4.54% 4.98% 4.39% 3.68% 12.0 12.5 11.5
Materials 3.82% 1.99% 2.54% 3.25% 13.5 27.6 17.6
Telecom 4.20% 3.89% 3.31% 3.10% 10.9 13.5 12.9
S&P 500 100.00% 100.00% 100.00% 100.00% 13.7 16.9 13.7

With more than 25 years of experience as an analyst and portfolio manager, Dirk van Dijk is Zacks' Chief Equity Strategist. He also manages the new long-term investing service, Strategic Investor.

Data in this report, unless stated otherwise, is through the close on Thursday 8/27/2009

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