October 10, 2012

Earnings Roundup: Earnings Preseason Offers Little Hope of Wave of Positive Surprises

by Greg Harrison

If you have been counting on S&P 500 companies to defy analysts’ predictions once more by announcing better-than-expected revenue and earnings for the third quarter, you may want to rethink: the results from the third-quarter “preseason” reporting period suggest that this time the odds favor more negative surprises.

The third-quarter earnings season marked its quasi-official opening yesterday, when Alcoa Inc. (AA.N) reported its results after the closing bell; results that may have been better than analysts were expecting but that still marked a dramatic decline in earnings from year-earlier levels. Currently, analysts expect companies in the Standard & Poor’s 500-stock index to report that their profits declined 2.9% from the year-ago third quarter; that would be the first year-over-year decline in corporate earnings witnessed since the third quarter of 2009. This estimate has been declining steadily over the past several months and investors are hoping that the lowered expectations will set the stage for positive earnings surprises once companies report.

But even before the reporting period “officially” began, the outlook for corporate profits was looking grim, based on the 5% of companies in the S&P 500 that announced their results. Earnings preseason results have historically been predictive of earnings results for the remainder of an earnings season. When an above-average percentage of companies beats earnings estimates during the preseason, the rate at which the rest of the companies beat their own estimates tends to be higher, too, with some two-thirds of those companies announcing higher-than-expected profits. But the opposite also holds true.

Of the 26 S&P 500 companies that have reported their third-quarter earnings results in the preseason, only 14 have reported profits that were higher than analysts’ estimates. This “beat” rate of 54% is significantly below the long-term average of 63%. That suggests that we may see fewer positive surprises than normal as the rest of the quarter’s results come flooding in over the next few weeks. That doesn’t augur well for corporate earnings, given that analysts already had such low expectations.

Companies have had similar results when it comes to hitting or exceeding analysts’ estimates for their revenues. In the preseason, 54% of S&P 500 companies have announced top-line figures that exceeded analyst expectations, while 46% companies fell short. This is an improvement on the revenue results from last quarter, when only 41% of companies beat estimates – a post-financial crisis low. Still, while it may be better than the second-quarter result, the rate at which companies are posting positive surprises on revenues still falls short of the long-term average of 62%.

Companies that report their results during the preseason tend to represent economically sensitive sectors of the S&P 500, such as Consumer Discretionary, Industrials, and Materials. Conversely, companies that belong to some of the more defensive sectors like Health Care, Telecommunications Services, and Utilities report later, which may affect preseason data.

Of the sectors with companies that have reported their results so far, the Materials sector is notable: not only did analysts have very low expectations going in to the end of the quarter, but companies that have reported their results thus far have announced even weaker figures. Overall, analysts expect the sector to report a 24% decline in profits; the two companies that have reported in the preseason, Mosaic Co. (MOS.N) and Monsanto Co (MON.N), have both posted significant negative surprises on both earnings and revenues. When Alcoa announced its own results yesterday, investors received more bad news in the form a 80% plunge in earnings to only three cents a share, compared to 15 cents in the year-ago quarter.

At least the Consumer Discretionary sector is off to a relatively strong start. Analysts are calling for the sector to record the highest rate of earnings growth of all groups within the S&P 500 index, of 7.9%. Better still, the companies that have reported their results so far have beaten estimates by an aggregate of 5.4%. The recovery in the housing market accounts for a lot of that, with homebuilder Lennar Corp. (LEN.N) announcing a 41% positive earnings surprise, posting earnings of 40 cents per share and 12% growth in sales at Bed Bath & Beyond Inc. (BBBY.O).

While there have been some bright spots so far, the overall earnings results have shown weakness. The odds remain, however, that the already-low expectations will be followed by even more disappointments as investors digest the reports that companies will be issuing over the coming weeks.

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