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The Earnings Picture
While we started out the fourth quarter earnings season on a very weak note, the picture has improved as the season has worn on. I would not want to suggest that this has been a good earnings season, but it is not the ugly one it appeared to be just a few weeks ago.
So far, 357, or 71.4% of the S&P 500 firms have reported. However, assuming that all the remaining firms report exactly in line with expectations, then 81.9% of all earnings are in.
Normally, when all is said and done, the median surprise runs about 3.00% and the ratio about 3.0. So far, the median is at 2.25% and the ratio is 2.31. Both are up from last week -- and up for the third week in a row -- but still well below normal. While we don’t have the drama of multi-billion-dollar bank losses, this is still the weakest earnings season since the depths of the Great Recession.
In most recent quarters, we have started out of the gate much faster than 3%, only to fade towards it; this time the reverse is true, but we are running out of real estate to catch up. Total net income for the 357 that have reported is 5.43% above a year ago. It is still less than a third the 17.42% growth rate that the same 357 firms reported in the third quarter.
The picture is just a little bit better if we take the Financials out of the picture. Without them, the year-over-year rise in net income is 7.76%, down from 20.06% growth in the third quarter. Sequentially, total net income so far is 6.87% below the third quarter, or 5.52% lower ex-Financials. The pressure on the growth rate is coming from both the numerator and the denominator.
The bar is also set low for the remaining 143 firms, and significantly lower than the results we have seen so far. They are expected to see year-over-year growth of just 2.03%. If we exclude the Financial sector, earnings are expected to be 6.70% below last year’s. That is below the 2.10% total and 6.87% ex-Financial growth those 143 reported in the third quarter.
Revenue growth has held up better, with the 357 reporting 6.70% growth. Most of the revenue weakness, though, has come from the Financials. If we exclude the Financials that have reported, revenue is up 8.39% year over year. The 143 are expected to see revenue growth to slow to negative 1.14% in total and positive 7.49% excluding the Financials. In the third quarter, the 143 reported revenue growth of 8.45% in total and 9.22% excluding the Financials.
The End of Net Margin Expansion
With revenue growth slowing, but holding up better than net income growth, it means that the net margin expansion game is coming to an end. It has been a very big part of the spectacular earnings growth that we have seen coming out of the Great Recession.
For the 357, net margins have come in at 9.73%, down from 9.85% a year ago, and down from 10.57% in the third quarter. For the 143, margins are expected to be much lower, but they are lower margin businesses to begin with. They are, however, expected to rise to 6.50% from 6.30% last year, and up from the 5.70% in the third quarter. That is entirely due to the remaining Financials. Excluding Financials net margins of just 5.73% expected, down from 6.61% a year ago and 5.98% in the third quarter.
While in an absolute sense those are still very healthy net margins -- much higher than the average of the last 50 years or so -- they are no longer expanding. Then again, it was unrealistic to expect that they would always rise. It does mean that earnings growth is going to be harder to come by going forward.
Switching Our Focus to 2012 and ‘13
This week we make the switchover on an annual basis from looking mostly at 2011 and 2012 earnings, revenues and margins, to looking at 2012 and 2013. FY1 is now referring to 2012 earnings, and FY2 is looking at mostly 2013 earnings. Both earnings and revenues are currently expected to continue to grow in 2013, but both at anemic low-single-digit rates, with revenue growth holding up somewhat better than earnings growth.
On an annual basis (all 500), net margins continue to march northward, but we are beginning to see cracks there as well. In 2008, overall net margins were just 5.88%, rising to 6.27% in 2009. They hit 8.39% in 2010 and are expected to continue climbing to 8.97% in 2011 and 9.61% in 2012. The very preliminary expectation is that they will dip to 9.48% in 2013. The pattern is a bit different if the Financials are excluded, as margins fell from 7.78% in 2008 to 6.93% in 2009, but have started a robust recovery and rose to 8.12% in 2010. They are expected to rise to 8.58% in 2011. They are expected to drop to and 8.00% in 2012, but then fall to 8.83% in 2013.
Total net income in 2010 rose to $788.8 billion in 2010, up from $538.6 billion in 2009. The expectations for the full year are very healthy. In 2011, the total net income for the S&P 500 should be $895.2 billion, or increases of 44.5% and 15.1%, respectively. The expectation is for 2012 to have total net income come close to $1 Trillion mark to $982.3 Billion, for growth of 9.7%. Total net income is expected to finally pass the $1 Trillion mark in 2013 at $1.014 Trillion.
The “EPS” for the S&P 500 is expected to be over the $100 “per share” level for the first time at $103.60 in 2012. That is up from $56.79 for 2009, $81.99 for 2010, and $94.41 for 2011. In an environment where the 10-year T-note is yielding 1.97%, a P/E of 14.3x based on 2011 and 13.1x based on 2012 earnings looks attractive. The P/E based on 2012 earnings is just 12.6x.
Busy Season for Estimate Revisions
Estimate revisions activity is rising fast, and approaching a seasonal peak. In previous earnings seasons we have generally seen a bounce in the revisions ratio, as the analysts have reacted to better-than-expected earnings and the outlooks on the conference calls. So far there is no evidence of that happening this time.
The revisions ratio for FY1, which is mostly 2012 earnings, now stands at 0.67, or three cuts for every two increases. The picture for FY2, mostly 2013, is only slightly better, with a revisions ratio of just 0.75. The widespread cuts are also confirmed by the ratio of firms with rising mean estimates to falling mean estimates, which now stand at 0.67 and 0.71, respectively.
As the earnings season has progressed, things have been getting a bit better, but only moved the season from being very poor to mediocre. This is happening when the bar is set at its lowest point in a very long time. For the remaining firms, the bar is set even lower.
The market has been off to a very strong start of the year, despite the weak early results. Valuations are still compelling, if somewhat less so than a few months ago. However, if the results do not improve, it strikes me as likely that we will at least pause for a while.
The upcoming week will be a busy one, with 69 S&P 500 firms scheduled to report.