April 23, 2012

Earnings Roundup: Positive Surprises Set New Record Thanks to Bearish Analyst Forecasts

by Greg Harrison

The only thing missing from the most recent batch of corporate earnings reports were celebratory fireworks, as an astonishing 80% of companies in the Standard & Poor’s 500-stock index that announced their results for the first quarter beat analysts’ expectations, a rate that will be the highest on record if it persists. But while the number of companies posting positive earnings surprises was cause for jubilation, the magnitude of those gains was underwhelming. Collectively, these companies posted earnings that were only 3.5% above forecast levels, compared to the average 3.6% positive surprise. In other words, while more companies may be beating estimates, they are doing so in a more muted fashion.

Last week alone, 83% of the 81 S&P 500 companies that announced their results posted a positive surprise. That suggests that earlier data signaling stronger-than-anticipated earnings growth was more than just a statistical anomaly based on a small sample size, but instead indicates a trend may be taking shape that is radically different from the one that most analysts and investors had feared. As these companies posted robust earnings one after the other last week, so the estimated growth rate for S&P 500 earnings has been ratcheted upward, almost hourly. (The magnitude of those revisions can be clearly seen in the chart below.)

Currently, the growth estimate for first-quarter S&P 500 earnings growth stands at 4.6%, well above the the levels forecast before the beginning of earnings season earlier this month, when most expectations were for S&P 500 earnings to grow by less than 3%. That rate could grow still further, assuming that the pattern continues and a far greater number of S&P companies continue to report far greater rates of earnings growth than analysts had anticipated. So far this quarter, that growth rate stands at 4.9%.

With the benefit of hindsight, it seems clear that analysts were excessively cautious and conservative as they calculated their earnings forecasts over the course of the first three months of the year. Indeed, it now seems clear that even as they were becoming more bearish with respect to corporate earnings growth, many of the companies they tracked were quietly booking healthy profits. As a result, with the arrival of earnings season, companies had an easy hurdle to clear in terms of posting an earnings surprise.

Of the 84% of S&P 500 companies reporting their results this week that beat earnings estimates, a significant number came from the Financials sector, where 20 of the 27 companies reporting post positive earnings surprises. (See the chart below for details.) The two largest positive surprises in dollar terms have come from the large banks, led by JPMorgan Chase’s (JPM.N) positive surprise, which added $496 million to the bank’s bottom line. In aggregate, the companies in the Financials sector have earnings that lag estimates by about 0.5%, however.

Companies from the Information Technology sector also are beating estimates handily, even without the benefit of a positive surprise by Apple (AAPL.O), which reports its results this week. Of the 14 companies in the group that reported their quarterly results last week, 11 announced positive surprises. International Business Machines Corporation (IBM.N) handily beat its estimate of earnings of $2.41 per share, reporting instead that it had earned $2.78 billion during the quarter thanks to continued international growth (and in spite of concern about the economic health of Europe and the prospect of softer growth in China. Mark Loughridge, IBM’s chief financial officer, noted during the earnings conference call that the United Kingdom has delivered 10 consecutive quarters of growth for the company, including 10% in the just-ended period; even Spain, Loughridge commented, has contributed to IBM’s earnings growth in each of the last six quarters. Results from the emerging markets also has proved robust, Loughridge noted. “Altogether, we had double-digit growth in 40 growth market countries,” he told conference call listeners. “We’re accelerating our market expansion initiative to continue that success.”

Not all companies were as upbeat about the prospects for global economic growth this year. The Coca-Cola Company (KO.N), despite delivering better-than-expected revenues and profits for the first quarter, acknowledged the difficulties that the European economic malaise has caused for consumers in that corner of the world. Coca-Cola posted a 2.9% positive surprise on revenues, which rose 5.6% to $11.1B, and a 1.8% positive surprise in earnings, which rose 3.5% to 89 cents a share. Muhtar Kent, the company’s chairman and CEO commented on the worrying slump in European consumer confidence, now at its lowest levels since 2009, and attributed it to austerity measures adopted by a range of administrations in various parts of the continent. Kent appeared less anxious about the situation in China, noting that the current slowdown in economic growth of late “is a natural progression and that it is a positive for the long-term sustainable growth of the country.”

The strong results reported this week indicate that fears that S&P 500 earnings might end up nearly flat for the first quarter may have been exaggerated. True, the current estimate of a 4.6% increase in earnings will still mean that corporate profits for the S&P 500 are growing at their slowest pace in more than two years. But the broad trend remains intact –earnings surprises continue to be significantly better than expected, providing psychological support for the stock market. So far, at least, the first-quarter earnings reports encourage investors and analysts to take a significantly more optimistic view of the economy than estimates earlier in the year.

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