Quarterly earnings: When great isn't good enough
Second-quarter reports are shaping up to be better than expected, but there's still reason for concern about the rest of the year.
We're not quite done with earnings season yet, but with second- quarter results in from 89% of the S&P 500, the overall picture of corporate profitability has become clear -- and it's surprisingly good.
In fact, earnings from April through June are on pace to set an all-time record. Of the 445 companies in the S&P 500 that have reported earnings so far, 64% posted profits that topped expectations -- better than the 62% average over the past 10 years, according to S&P Capital IQ.
Contrary to forecasts that had corporate profits shrinking, earnings growth for the S&P 500 overall is on pace to come in at under 1%. "At the beginning of the season we were expecting negative growth of like 2%," says Christine Short of S&P Global Markets Intelligence. "So although it's not as positive as we'd like to see and certainly not as positive as we've gotten used to over the last 10 quarters, it still is a surprise to see it pop up into positive territory."
Overall, earnings per share for the 500 companies are on track to total $25.68, outpacing the record $25.46 posted in the second quarter of 2011. "In a difficult economy," says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, "these companies have managed to set an all-time record, whichever yardstick you want to use." For the full year, the S&P 500 companies are projected to earn about $103 a share, up from last year's record of $99.
But if the second quarter wasn't quite as bad as predicted, there's still plenty of concern about the slowing rate of earnings growth and how companies will fare this quarter and next. "Now with Q2 pretty much in the rearview mirror, everyone's focusing on the next quarter," says John Butters, senior earnings analyst at FactSet, "and the numbers don’t look good."
Obviously, year-over-year earnings growth of less than 1% last quarter, as surprising as it may be, is still nothing to crow about -- it marks the lowest increase since the third quarter of 2009, just after the official end of the recession. And some sectors have done substantially worse.
At the same time, many of the companies that grew earnings were able to do so because of cost-cutting rather than increased sales. "Companies were able to eke out the bottom-line wins this quarter. We saw a lot of companies cutting costs, a lot of workforce reductions," says Short. "I don't think in the second half of the year they're going to be able to implement those large cost-management plans as they've been able to throughout 2011 and the first half of 2012. At some point you've got to grow revenues, and companies aren't having success with that right now."
Revenue growth is on track to come in at 2.2% in the second quarter, according to S&P Capital IQ, down from 6% in the first quarter and 12% in the second quarter of last year. While companies have been adept at managing earnings expectations, they haven't done as well on the revenue front: just over 40% of the companies have beaten expectations on the top line, some 20 percentage points below the historic average. And sales in the current quarter are projected to grow even more slowly -- or shrink.
As sales growth slows, corporate America's streak of 11 consecutive quarters of earnings growth looks to be in jeopardy. Profits for the S&P 500 companies are now expected to slip about 1.5% this quarter -- much lower than the 3.25% gain that analysts had been forecasting in early July.
"It's kind of a double-edged sword," says Butters. "At some point you're not going to keep seeing great growth because it's [hard to keep generating] record profit on top of record profit. But at the same time, the market never likes to see year-over-year declines in earnings and companies lowering expectations."
As they announce their results for last quarter, companies have been bringing up familiar concerns about the current one. Of the 83 companies that had guided analysts about the third quarter as of Thursday morning, 59 were negative. "Companies, in their press releases and on their conference calls, are saying Europe is our toughest region, but it's not just Europe anymore," says Short. "There's slowing in China. In 2011, we were able to offset weak sales in Europe with the growth we were seeing out of China. That's not there anymore -- certainly not enough to offset any weakness in Europe. And then sales in the U.S. aren't doing as well as they were in the last couple of years. It's an overall global issue at this point." Blue chips including 3M, General Electric, McDonald's and Pfizer have also cited currency effects of a strong dollar as undercutting their gains.
And while analysts are still officially expecting a sharp rebound in the fourth quarter -- the consensus estimate now calls for a Pollyannaish 10.5% earnings growth, a number that's sure to come down as we get closer to the end of the year -- it's hard to see how companies get that kind of boost to profits.
But while Wall Street traders, CEOs and CFOs play the earnings expectations game, it's still worth keeping the numbers in some perspective. "The bottom line is you've got an all-time record here," says Silverblatt, "and to turn around and say, well, that means that next quarter I'm not going to be doing as well is like winning the lottery and then saying my income is going to go down next year unless I win the lottery again."
Yuval Rosenberg is a Business+Economy editor at The Fiscal Times. Subscribe to The Fiscal Times' FREE newsletter.
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