January 28, 2013

Earnings Roundup: Fourth-Quarter Earnings Season Sees Dramatic Rate of Positive Surprises

by Alpha Now Research Team

Companies are reporting positive surprises at an impressive rate, handily beating analysts’ forecasts. Still, those forecasts had been lowered significantly in earlier weeks, and the fate of Apple (AAPL.O) demonstrated clearly that a positive surprise may not be enough to encourage investors if it is accompanied by a year-over-year decline.

The fourth quarter earnings season may have started on a bumpy note, but the rate at which companies in the S&P 500 either beat or exceeded analysts’ forecasts when reporting their actual results last week helped make S&P 500 fourth-quarter results look much brighter. As seen in Exhibit 1, below, 73% of companies that reported their results last week posted positive earnings surprises, while 63% announced better-than-expected revenues. The improvement on the revenue front was particularly notable, given the fact that during the second and third quarters, only 41% and 39%, respectively, of S&P 500 companies posted positive revenue surprises.

Large numbers of Industrials and Information Technology companies dominated the list of S&P 500 companies reporting last week. Coming into the earnings reporting season, analysts’ expectations for these companies were low; indeed, analysts predicted that Industrials companies would announce an average earnings decline of 5.5% for the period (the weakest rate of earnings growth of any sector), with Information Technology following just behind, with a forecast decline of 1% in earnings growth. But companies in both sectors found those lower expectations easier to beat: 78% of Industrials companies announced better-than-expected earnings while an impressive 87% of Technology companies did the same. That’s well above the average 67% beat rate for all companies to have reported so far during this earnings season and the 62% that beat expectations during a typical reporting period.


One of the primary catalysts for this outperformance on the part of Industrials companies has been the performance of the Aerospace & Defense sub-industry. Analysts expect companies in this group to report a 17% decline in earnings, as government spending take a toll on revenues and profits. Despite the looming prospect of further such spending cuts, several of these businesses managed to do better than anticipated, even though the earnings they announced were below year-earlier levels. Lockheed Martin Corporation (LMT.N), for instance, announced that its profits for the period totaled $1.19 a share, a 10.7% drop from the year earlier. Still, that is significantly better than the $1.82 that analysts had predicted it would earn and thus helps to reduce the sector’s aggregate decrease in earnings.

Outside of the aerospace industry, other companies in the Industrials sector also fared better than expected. Southwest Airlines (LUV.N) announced earnings of 9 cents per share, a penny above analysts’ expectations, thanks to a strong season for travel during the holiday period late last year. That put more fare-paying passengers in Southwest’s airline seats – and generated enough additional revenue to produce a positive earnings surprise.

At the beginning of January, analysts believed that profits in the Information Technology sector would decline by 1%, a change in direction for what in recent quarters has been one of the strongest sectors in terms of earnings growth. At the beginning of October, that aggregate forecast was for growth of 9.4% in technology companies’ earnings, but that figure was dramatically overturned by downward revisions by analysts, for their part spurred on by warnings and other guidance from the companies themselves during the third-quarter reporting season. All of that pessimism gave technology companies a low bar to clear, and many of them proceeded to do just that, to the point where the earnings growth estimate for the sector has bounced back into positive territory with a 1.2% increase.

Of course, for some companies, a better-than-expected bottom line wasn’t all that investors were looking for. Apple Inc (AAPL.O) beat its $13.47 earnings estimate when it announced a profit of $13.81 per share. But while this may have been a positive surprise, it also marked the first time in more than ten years that the company failed to demonstrate year-over-year earnings growth. Indeed, Apple – out of favor in the market for some months now – has become a drag on overall earnings growth for the Information Technology sector and the S&P 500 index an a whole, a complete change from many quarters in which it helped fuel gains for both.

Google Inc (GOOG.O), on the other hand, continues to grow at an impressive pace. It announced that its revenue soared 49.5% in the just-ended quarter, while earnings climbed 11.5%; the $10.59 a share in profits that the company reported handily beat the analysts’ consensus forecast of $10.42 a share as the company extends its forays into the world of hardware through its investments in smartphones, notebooks, and tablets.

The positive surprises over the past week have boosted the overall blended earnings growth estimate to 2.9% from 2.3% only a week ago. Of the 150 S&P 500 companies that have reported to date, that actual growth is higher still, at 7.0%. The fact that the blended estimate is so much lower than the actual growth of the companies that have reported implies that analysts believe that those companies that have yet to report their results will post a smaller growth in profitability than we have seen to this point. But if the positive surprises continue, earnings growth could turn out to be higher than anticipated for the fourth quarter, salvaging what analysts had initially forecast would be another quarter of slow growth.

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