With the strong third quarter earnings season now well behind us, the focus turns to the forth quarter season which kicks off this week when Alcoa (AA), Intel (INTC) and J.P. Morgan (JPM) report. We have already had a handful (24) of S&P 500 firms report, but they were mostly firms with November fiscal period ends, with a high proportion of retailers in the mix.
While far from a representative sample, the early reports are encouraging, with total net income for those firms rising 25.4% over a year ago. The early median surprise of 6.07% is also quite strong, although the ratio of positive to negative surprises is a bit weaker than normal at just 2.50%. However, those numbers are always extremely volatile in the early going and it is far too early to draw any real conclusions about the quarter.
Positive Expectations
Most of the focus should be on the expectations for those who have yet to report. There the expectations are also positive, particularly on the earnings front. Total net income is expected to rise 19.8% over year-ago levels. While that is a slowdown from the year-over-year growth of the third quarter (25.1%), it is well above the growth that was expected for the third quarter just before the third quarter reporting season really got underway (15.5%).
Given that positive earnings surprises almost always outnumber disappointments, one does not need an overly active imagination to envision that growth will be close to 25% again when all is said and done for the quarter. Revenue growth, though, is expected to slow down significantly to an actual slight decline of 0.09% from positive growth of 8.01% in the third quarter. On the other hand, revenue growth among the handful that have reported is very healthy at 10.1%.
The financials are a big part of the overall revenue growth slowdown, but not the entire story. Excluding them, revenue growth is expected to slow to 3.02% year over year from 9.12%. Tougher year-over-year comparisons are a bigger part of the story.
Net Margin Expansion
Thus, the stellar earnings growth is mostly due to the continued expansion of net margins. Much of the year-over-year margin expansion is due to the financials, were the whole concept of revenues is a bit different from most companies, and thus the concept of net margins is also a bit different.
However, even if the financials are excluded, net margins continue to march northward, at least year over year. For the S&P 500 as a whole, net margins are expected to be 8.85% in the fourth quarter, up from “just” 7.38% a year ago, but down from 9.11% in the third quarter. If the financials are excluded, margins are expected to rise to 8.20% from 7.97% a year ago but down from 8.80% a year ago. Those numbers are for the vast majority that have yet to report.
The reported net margins among the 24 early birds are 3.56%, up from 3.14% a year ago but down from 3.76% in the third quarter. Fully one third of all the companies that have reported are retailers, however, and retailers tend to have low margins.
Forecasts for 2010 & 2011
The expectations for the full year are very healthy, with total net income for 2010 expected to rise to $778.5 billion in 2010, up from $544.3 billion in 2009. In 2011, the total net income for the S&P 500 should be $896.4 billion, or increases of 42.9% and 15.1%, respectively.
If the early expectations for 2012 prove to be correct, that year will mark two significant milestones. Total net income is expected to reach $1.0036 Trillion, marching passed the $1 Trillion level for the first time ever. That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $106.15. That is up from $57.64 for 2009, $82.18 for 2010, and $95.06 for 2011.
In an environment where the 10-year T-note is yielding just 3.32%, a P/E of 15.5x based on 2010 and 13.4x based on 2011 earnings looks attractive. Much of the $600 billion in newly created money from QE2 is likely to eventually find its way into the equity market (not directly, but eventually).
Historically, the year after mid-term elections has almost always been a good one for the stock market. The extension of unemployment benefits and the one-year cut in the payroll tax should be stimulative to the economy (the extension of the high-end tax cuts is only slightly stimulative relative to letting them expire, and certainly does not provide any fresh stimulus to the economy). A stronger economy should allow earnings to continue to rise.
A Few Caveats
On the other hand, there is a very real prospect of total political gridlock, which would greatly raise uncertainty about governmental policy and the strength of the economy that could undermine confidence. As Shakespeare said: “Beware the ides of March.” That is approximately when the U.S. will hit its current debt ceiling. If it is not raised, the U.S. Government would go into at least a technical default on its debt, and the government would probably have to shut down.
That is hardly something that will inspire confidence in the markets. While it is inconceivable that it will not eventually be passed, it is an opportunity for major political theater, and there is a chance that there will be a delay between the debt ceiling being hit and when it gets raised.
The economy does seem to have made a slow turn towards recovery. However, job creation remains very sluggish. Most of the real growth in the economy has come from higher productivity, not more hours being worked. Those productivity gains are accruing to capital, not labor, and are a major reason behind the strong earnings growth.
Earnings Growth to Power Forward
Still, companies are expected to continue growing their earnings nicely, and the 15.1% expected growth for 2011, if achieved, means that the total earnings for the S&P 500 should hit a new record by the middle of next year. The fact that analysts are, on balance, still raising estimates for 2011, increases the odds that that growth will be achieved. Growth of 15.1% is not exactly awful.
Even on the revenue side the expected growth in 2011 of 5.38%, or 5.88% if one excludes the financial sector, is still pretty solid. Clearly the analytical community is not expecting the economy to turn south again.
This was excerpted from the edition of Earnings Trends from 1/10/11. For more detail, including breakdowns by the 16 Zacks Economic Sectors, scroll down on the Zacks.com home page.
ALCOA INC (AA): Free Stock Analysis Report
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Positive Expectations
Most of the focus should be on the expectations for those who have yet to report. There the expectations are also positive, particularly on the earnings front. Total net income is expected to rise 19.8% over year-ago levels. While that is a slowdown from the year-over-year growth of the third quarter (25.1%), it is well above the growth that was expected for the third quarter just before the third quarter reporting season really got underway (15.5%).
Given that positive earnings surprises almost always outnumber disappointments, one does not need an overly active imagination to envision that growth will be close to 25% again when all is said and done for the quarter. Revenue growth, though, is expected to slow down significantly to an actual slight decline of 0.09% from positive growth of 8.01% in the third quarter. On the other hand, revenue growth among the handful that have reported is very healthy at 10.1%.
The financials are a big part of the overall revenue growth slowdown, but not the entire story. Excluding them, revenue growth is expected to slow to 3.02% year over year from 9.12%. Tougher year-over-year comparisons are a bigger part of the story.
Net Margin Expansion
Thus, the stellar earnings growth is mostly due to the continued expansion of net margins. Much of the year-over-year margin expansion is due to the financials, were the whole concept of revenues is a bit different from most companies, and thus the concept of net margins is also a bit different.
However, even if the financials are excluded, net margins continue to march northward, at least year over year. For the S&P 500 as a whole, net margins are expected to be 8.85% in the fourth quarter, up from “just” 7.38% a year ago, but down from 9.11% in the third quarter. If the financials are excluded, margins are expected to rise to 8.20% from 7.97% a year ago but down from 8.80% a year ago. Those numbers are for the vast majority that have yet to report.
The reported net margins among the 24 early birds are 3.56%, up from 3.14% a year ago but down from 3.76% in the third quarter. Fully one third of all the companies that have reported are retailers, however, and retailers tend to have low margins.
Forecasts for 2010 & 2011
The expectations for the full year are very healthy, with total net income for 2010 expected to rise to $778.5 billion in 2010, up from $544.3 billion in 2009. In 2011, the total net income for the S&P 500 should be $896.4 billion, or increases of 42.9% and 15.1%, respectively.
If the early expectations for 2012 prove to be correct, that year will mark two significant milestones. Total net income is expected to reach $1.0036 Trillion, marching passed the $1 Trillion level for the first time ever. That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $106.15. That is up from $57.64 for 2009, $82.18 for 2010, and $95.06 for 2011.
In an environment where the 10-year T-note is yielding just 3.32%, a P/E of 15.5x based on 2010 and 13.4x based on 2011 earnings looks attractive. Much of the $600 billion in newly created money from QE2 is likely to eventually find its way into the equity market (not directly, but eventually).
Historically, the year after mid-term elections has almost always been a good one for the stock market. The extension of unemployment benefits and the one-year cut in the payroll tax should be stimulative to the economy (the extension of the high-end tax cuts is only slightly stimulative relative to letting them expire, and certainly does not provide any fresh stimulus to the economy). A stronger economy should allow earnings to continue to rise.
A Few Caveats
On the other hand, there is a very real prospect of total political gridlock, which would greatly raise uncertainty about governmental policy and the strength of the economy that could undermine confidence. As Shakespeare said: “Beware the ides of March.” That is approximately when the U.S. will hit its current debt ceiling. If it is not raised, the U.S. Government would go into at least a technical default on its debt, and the government would probably have to shut down.
That is hardly something that will inspire confidence in the markets. While it is inconceivable that it will not eventually be passed, it is an opportunity for major political theater, and there is a chance that there will be a delay between the debt ceiling being hit and when it gets raised.
The economy does seem to have made a slow turn towards recovery. However, job creation remains very sluggish. Most of the real growth in the economy has come from higher productivity, not more hours being worked. Those productivity gains are accruing to capital, not labor, and are a major reason behind the strong earnings growth.
Earnings Growth to Power Forward
Still, companies are expected to continue growing their earnings nicely, and the 15.1% expected growth for 2011, if achieved, means that the total earnings for the S&P 500 should hit a new record by the middle of next year. The fact that analysts are, on balance, still raising estimates for 2011, increases the odds that that growth will be achieved. Growth of 15.1% is not exactly awful.
Even on the revenue side the expected growth in 2011 of 5.38%, or 5.88% if one excludes the financial sector, is still pretty solid. Clearly the analytical community is not expecting the economy to turn south again.
This was excerpted from the edition of Earnings Trends from 1/10/11. For more detail, including breakdowns by the 16 Zacks Economic Sectors, scroll down on the Zacks.com home page.
ALCOA INC (AA): Free Stock Analysis Report
INTEL CORP (INTC): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis Report
Zacks Investment Research
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