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The fourth quarter earnings season is almost four-fifths over. So far, 396 S&P 500 firms have reported. Despite some high profile misses, so far the results look pretty strong. Positive surprises have out numbered disappointments 251-84, with 61 hitting expectations exactly. The median growth rate of the firms that have reported is 14.3%. It now seems clear that this will mark the 15th straight quarter of double-digit earnings growth for the S&P 500. With 79.2% of the precincts in, we are prepared to make a call on this “election”. This was a good quarter for corporate earnings growth. With better than a 3:1 ratio of positive surprises over disappointments, it looks like it is shaping up as a landslide.

Looking at yearly growth, it looks like this run of strong earnings growth still has room to go. On a median firm basis, earnings growth is expected to be 13.2% in 2005, 12.2% in 2006 and 12.4% in 2007. On a total earnings basis, growth is expected to be 11.6%, 12.4% and 9.9%, respectively. Interestingly, the median expected 2006 growth rate is higher for firms that have reported than it is for those firms that have yet to report. The differential is particularly large in the Energy sector where those that have reported are expected to grow 13.0% in 2006, while the median for those that have yet to report is 75.4%%.

Earnings growth in 2005 was dominated by the Energy sector, but this year, growth is expected to be more evenly distributed. This said, the Energy sector should still post the highest growth sector, especially on a median basis. Energy is expected to lose earnings share in 2007. However, earnings estimates are being revised upwards for the Energy sector for both 2006 and 2007, thus earnings are likely to come in higher than is currently expected.

The Consumer Staples, Financial and Health Care sectors are seeing a preponderance of estimate cuts for both 2006 and 2007. Estimates are being revised upwards for the Energy, Industrial, Materials and Telecom sectors for both 2006 and 2007. The estimate increases for Energy, Telecom and Materials are exceptionally pronounced for 2007. Pay close attention to the estimate revisions, since they are a much better predictor of stock market performance than growth rates are. Overweight sectors with rising estimates and underweight those will falling estimates.

• For 2006, over the last month, 226 firms have seen estimate increases, while 255 have been cut for 2006 a ratio of 0.89, unchanged from last week. The average estimate fell 0.11%.
  
• For 2007, the estimates rose for 236 and fell for 220, a ratio of 1.07, down from last week’s reading of 1.13. The average estimate rose 0.16%.
  
• A total of 1,618 2006 estimates were increased over the last month for this year while 1,569 were cut, a ratio of 1.03, up slightly from last weeks 1.02.
  
• For 2007, 854 estimates were increased and 687 were cut, a ratio of 1.24, up from 1.14 last week.
  
• Median expected growth rates for S&P 500 firms at 13.2% for 2005, 12.2% for 2006 and 12.4% for 2007.
  
• Total net income for the S&P 500 expected to rise 11.6% in 2005, 12.4% in 2006 and a further 9.9% in 2007.
  
• Estimate trends very strong for Energy, Telecom, Materials and Industrials, weak for Financials, Health Care and Consumer sectors.
  
• Energy and Financials cheap on 2006 P/Es; Tech, Health Care and Consumer sectors look expensive

Note: EPS growth compares current quarterly results versus prior year ago quarter. It applies only to those firms which have reported.

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Highlights

• 396 firms have reported for the fourth quarter¹, with 251 positive surprises and 84 disappointments.
  
• Every sector has more positive surprises than disappointments. Overwhelming preponderance of positive surprises in the Industrial, Utility, Technology, Energy and Consumer Discretionary Sectors.
  
• Disappointments concentrated in the Financial and Consumer Staples sectors.
  
• Median year-over-year growth of 14.3% (so far) points to 15th straight quarter of double-digit year-over-year growth.
  
• Firms which have yet to report have median expected growth of 11.4%
  
• For the firms that have already reported, earnings growth is expected to slow in the 1st quarter, 8.8% growth expected versus 14.3% reported in the 4th quarter so far.
  
• For all of 2006, growth is expected to be lower for seven sectors than the 4th Quarter 2005 pace.

¹Defined as the fiscal quarter ending in November, December and January. All data as of 2/9/06 close.

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• The median growth rate for firms in the Energy sector is 73.4% for 2005². This does not represent the earnings peak. A further 19.9% growth is expected in 2006. However, earnings are expected to rise only 2.3% in 2007.
  
• Energy sector growth in 2006 expected to be in the smaller companies, particularly the Drillers and Oil Service firms, not the giant Integrated Oils. Thus, total net income growth trails median growth for all three years (45.2%, 17.0% and -0.7%), respectively).
  
• Median growth rate expected for Consumer Discretionary sector (11.4%) in 2005 much higher than the total net income growth (-1.9) expected for the sector in 2005. The situation is reversed in 2006 (median 12.8% versus total net income growth of 16.2%) This is mostly attributable to trouble in Detroit in 2005 and a hoped for rebound in 2006.
  
• The median firm in the S&P 500 is expected to post double-digit earnings growth for 2005 (13.2%), 2006 (12.2%) and 2007 (12.4%).
  
• Telecommunications (4.7%) and Consumer Staples (5.3%) are expected to post the lowest growth in 2006. For Consumer Staples, growth is currently expected to rebound to 10.5% in 2007, while for Telecom it is expected to decline to 3.7%.

²We follow the convention of referring to the last completed fiscal year as 2005, and the current fiscal year as 2006 when discussing the aggregate data.

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When making investment decisions, growth should always be looked at in conjunction with how much you are paying for a stock. Thus, it makes sense to look at the total earnings expected for a sector relative to the total market capitalization for the sector³.

The chart below shows the share of total earnings for 2005, 2006 and 2007, as well as the share of total market capitalization for each sector (the final bar shown). Since the S&P 500 is a market cap weighted index, this is the same as its index weight. On the chart below, the differences between the size of the first three bars shows if a sector is gaining or losing “earnings share”. The difference between the final bar and the first three bars shows if the sector is selling for an above or below market P/E. If final bar is smaller than the other bars, the sector is selling for a below market P/E. However, as opposed to just showing the sector P/Es it also shows the relative importance of the sectors to the overall index.

Clearly the Financials are the biggest influence on the market, with a weight of 20.5%. Financials have more influence than the Energy, Utilities, Materials and Telecom sectors combined. However, that sector is also relatively cheap on an earnings basis, and thus serves to hold the overall P/E of the index down. In other words, Financials deserve to be the biggest influence on the market, since they contribute 25.7% of the total expected earnings for 2006, or more than the total earnings of the Tech, Industrial and Utility sectors combined.

Energy looks to be under represented in its influence on the market since it will provide 13.8% of the total earnings for 2005 and 14.4% for 2006, but represents only 9.5% of the total market capitalization of the index. While its earnings share is currently expected to decline to 13.0% in 2007, even on this basis it is still much cheaper than the overall market. I would note that only last week, the expected share was only 12.7%. When all is said and done, it is likely that the share of total earnings in 2007 for the sector will be far above the currently expected 13%. Clearly at 9.5%, Energy is far from being in a bubble phase. Energy and Financials are the only two sectors which look significantly cheaper than the overall market on the basis of 2006 earnings. Put another way, in the context of a flat market in 2006, Energy stocks would have to rise 52.4% for its index weight to match its earnings share.

Similarly, Financials would have to rise 24.8%, however it has been a long time since the Financial sector has traded at or above the market multiple. In addition, the estimates for the sector have been sinking, which indicates that the final share of earnings is likely to be lower than is currently being forecast. In contrast, Tech, Health Care and the Consumer Staples sectors look expensive. In more conventional terms, Energy and Financials are selling for weighted P/Es (total market cap/total earnings in 2006) of 9.8x and 12.0x, relative to the S&P 500 which is selling for 15.0x, while Tech, Health Care and Consumer Staples are selling for P/Es of 21.2x, 17.9x, and 17.3x, respectively. Health Care and Consumer Staples are also facing falling estimates, so the current earnings share is most likely overstated.

³In an institutional context, weighting by total expected earnings, rather than market cap would be a good way to create an enhanced index with a value tilt. Indexers are forced to weight overvalued stocks more than undervalued stocks since price is an integral part of market capitalization.

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• Estimate cuts for 2006 are concentrated in the Health Care, Utilities and Consumer sectors.
• Industrial, Materials, Telecom and Energy sectors have very strong estimate revision profiles for both 2006 and 2007.
• Weakness for the Consumer and Health Care sectors extend into 2007.
• Financials are also weak for both years.
• Average estimates rise by at least 1.75% for both years for Telecom, Energy and Materials.
• Energy, Telecom and Industrials are strong on all three dimensions of 2007 estimate revisions.

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Estimate increases and decreases for 2006 were closely balanced over the last month, but fewer firms had increasing than declining estimates. The overall revisions ratio rose to 1.03 from 1.02 last week. However, a total of 255 firms suffered declines in their mean estimates and 226 enjoyed increases. The average estimate has fell by 0.11% over the last month. Detroit drags Discretionary down, with large declines at F, DCN and CTB contributing significantly to the overall decline in the sector. GM dropped to an expected loss for the year, and as such is omitted from the calculation. The Consumer Staples and Health Care sectors are particularly noteworthy in their weakness, not only in terms of the average estimate change, but also in terms of the breadth of the cuts. Technology was a mixed bag, with big increases for AMD, UIS, BRCM, AMCC and NVLS being offset by significant declines at INTC, JDSU, LSI, LU and YHOO. There were not many major moves in the Financial Services sector, but in general the Brokerage stocks enjoyed estimate increases while the Banks suffered declines. The Consumer Staples sector was just plain ugly all around, but TSN in particular was plucked for a big decline. The big increase in the Telecom sector is mostly due to strength at Q. In the Materials sector, metals looked marvelous, but paper and chemicals were on the weak side. I would particularly highlight the increases at NUE, PD and VMC and the cuts at DD and MWV. In Energy, the Oil Service firms (HAL, SLB, BJS and WFT) were particularly strong.

⁴We exclude any estimate change less than -100% from these calculations for both years, including for Heath Care 2006 a -187.1% decline for THC, for Consumer Discretionary 2006 declines of -118.12 for GM and -203.7%, and for Technology declines of -209.5% and -217.2% for 2006 and 2007, respectively for SUNW.

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The consensus currently contains far fewer estimates for 2007 than for 2006, but this will change rapidly over the next few weeks. As this occurs, the mean estimates will be as influenced by new estimates entering the mix as it is from changes in existing estimates. That being said, the revisions we are seeing are starting off on a positive note. A total of 854 estimates for 2007 were increased, while 596 were cut, a ratio of 1.24, well above last week’s 1.13. A total of 236 firms enjoyed increases in their 2007 estimates over the last four weeks while 220 suffered declines. The average estimate rose 0.16%. There were a very large number of double-digit increases or cuts for individual firms this week as analysts make their initial estimates for 2007 or revise their expectations based on new information coming out with the fourth quarter results.

This is a “Tale of Two Cities” week. It is the best of times for estimate revisions for the Telecom, Materials, Industrial, Technology, Energy and Utilities sectors. It is the worst of times for the Consumer Staples, Health Care and Financial Service sectors. The huge increase in the mean estimate in the Telecom sector is mostly due to a big increase at Q, with supporting roles for T and BLS. In the Materials sector very significant strength in the metals and mining stocks (ATI, FCX, PD, NUE, NEM, X) was offset by some weakness in the Chemical (DD) and Paper (MWV, LPX) industries. Estimate increases were almost across the board in the Energy industry. The breath of increases (27) vs. declines (2) was reminiscent of the immediate post Katrina period. And these were not just marginal increases either, 12 of the 29 firms in the sector posted increases of more than 5.0% over the last month. I would note that the Oil Service firms were particularly strong. As the estimates rise, the expected growth rates also go up. Thus while the expected growth rate for the Energy sector in 2007 is currently very low, if the revisions trend continues, it is not inconceivable that the growth rate in Energy in 2007 will exceed that of the overall market (unless of course the estimates for 2006 are ratcheted up at the same or higher rate). The same is true of the Materials sector. The very large increase in the telecom sector’s average estimate is due to a less negative outlook for Quest, although strength in T and BLS played a supporting role. With only eight firms in the sector, the average is much more sensitive to company specific events than is true for other sectors.

The weakness in the Consumer Staples sector continues into 2007, with BUD, MO and TSN being particularly weak. The only firm showing significant strength in the sector was ADM, which is an Energy (Ethanol) play in the Staples sector. The average estimate fell 1.18% for the Consumer Staples. However, we might be seeing the start of a turn for the better in the Discretionary sector since there were an equal number of individual estimates raised as cut, and the ratio of rising to falling firms was actually positive. However weakness at DCM, EK, MYG and AMZN led to a 2.68% decline in the mean estimate for the sector. The Health Care sector also hit a weak note with the average estimate falling 1.05%. SGP and MEDI led the declines there. The Tech sector was mixed, with a large number of large estimate revisions in both directions. On the upside, AMD, AAPL, AMCC, CEIN, and BRCM were notable, while INTC, LU, LSI, UIS and ERTS were particularly weak.

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Below is a list of companies that should report this week.