Earnings Season in the Homestretch

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 409, or 81.8% of the firms have reported.  However, assuming that all the remaining firms report exactly in like with expectations, then 87.8% 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 2.31% and the ratio is 2.33.  Both up from last week, and up for the fourth 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 that only to fade towards those levels, this time the reverse is true, but we are running out of real estate to catch up.  Total net income for the 409 that have reported is 6.31% above a year ago.  It is about a third the 17.78% growth rate that the same 409 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 8.47%, down from 20.16% growth in the third quarter.  Sequentially, total net income so far is 6.45% below the third quarter, or 5.90% lower ex financials.  The pressure on the growth rate is coming from both the numerator and the denominator (year ago earnings growth was strong, and thus tougher comps).

The bar is also set low for the remaining 91 firms, and significantly lower than the results we have seen so far.  They are expected to see year over year growth of negative 2.32%.  If we exclude the Financial sector, earnings are expected to be 11.91% below last year’s.  In the third quarter, the remaining firms had growth of negative 6.96%, but it was just into positive territory at 0.80% if the financials are excluded.  In other words, we have started out weak, and it is expected to get worse.  Provided the remaining firms report in line with expectations, the final year over year growth should be 5.15%, up from 4.80% expected last week.

Revenue growth has held up better, with the 409 reporting 7.43% growth.   If we exclude the Financials that have reported, revenue is up 7.67% year over year.  The 91 are expected to see revenue growth to slow to negative 5.45% in total and positive 5.79% excluding the Financials.  In the third quarter, the 91 reported revenue growth of 3.95% in total and 6.21% excluding the financials.  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 409, net margins have come in at 9.65%, down from 9.75% a year ago, and down from 10.41% in the third quarter.  For the 91, margins are expected to be much lower, but they are lower margin businesses to begin with.  Retailers for example account for 33.6% of the remaining earnings expected. 

They are expected to rise to 5.84% from 5.65% last year, and up from the 4.75% in the third quarter. That is entirely due to the remaining Financials. Excluding Financials net margins of just 5.04% expected, down from 6.05% a year ago and 5.05% 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, but 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.

On an annual basis (all 500), net margins continue to march northward.  In 2008, overall net margins were just 5.88%, rising to 6.27% in 2009.  They hit 8.38% in 2010 and are expected to continue climbing to 8.96% in 2011 and 9.59% in 2012.  The very preliminary expectation is that they will rise to 10.20% 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 8.13% in 2010.  They are expected to rise to 8.59% in 2011.  They are expected to rise to 8.88% in 2012, and then up to 9.52% in 2013.  There should be some caution in using the 2013 numbers, as the analyst sample sizes are still well below those for 2012, especially when it comes to revenues.

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 $895.9 billion, or increases of 44.4% and 15.3%, respectively.  The expectation is for 2012 to have total net income come close to $1 Trillion mark to $981.2 Billion, for growth of 9.5%.  Total net income is expected to finally pass the $1 Trillion mark in 2013 at $1.0904 Trillion. 

The “EPS” for the S&P 500 is expected to be over the $100 “per share” level for the first time at $103.51 in 2012.   That is up from $56.79 for 2009, $81.96 for 2010, and $94.51 for 2011.  In an environment where the 10 year T-note is yielding 1.98%, a P/E of 14.4x based on 2011 and 13.1x based on 2012 earnings looks attractive.  The P/E based on 2013 earnings is just 11.8x. 

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.  The revisions ratio for FY1, which is mostly 2012 earnings now stands at 0.73, or more than four cuts for every three increases.  The picture for FY2, or mostly 2013 is only slightly better, with a revisions ratio of just 0.82. The widespread cuts are also confirmed by the ratio of firms with rising mean estimates to falling mean estimates, which now stand at 0.93 and 0.73, 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 60 S&P 500 firms scheduled to report.  Thus by the end of next week, earnings season will effectively be over, with 93.8% of the reports in.  Just two firms, Wal-Mart (WMT) and Berkshire Hathaway (BRK-B) account for almost 30% of the remaining expected earnings. 

Read the full analyst report on WMT

Read the full analyst report on BRK-B