Fourth-quarter earnings season kicks off Monday with Alcoa
) reporting after the close.
This earnings season promises to be wild and very hard to interpret.
Let me start with the narrow Alcoa story and then expand to look at the earnings season as a whole.
Alcoa has announced it will cut its aluminum production by 12% in reaction to falling prices. Aluminum peaked at $2,803 per metric ton in May and then fell 27% to $2,020 by the end of 2011.
Analysts have been busy cutting estimates for Alcoa's fourth-quarter earnings. Nine out of 12 analysts surveyed by Bloomberg expect the company to report a loss. The consensus estimate is for the company to report earnings of a penny a share. That would be a big drop from 21 cents a year ago and 21 cents analysts projected at the start of the most recent fourth quarter.
Of course, with so much negativity already out there, Alcoa stands a chance at beating that penny-a-share estimate. That would be especially likely if Wall Street decides to look past the big restructuring charges for the quarter. The company has estimated restructuring charges of 15 cents to 16 cents this quarter.
The charges are very real, but Wall Street is perfectly capable of arguing that they are one-time costs that don’t count in valuing the stock. That’s even though Alcoa looks like it has embarked on a long-term journey of cutting capacity in order to reduce costs in the highly competitive aluminum industry. The goal of this round of capacity reductions is to close the company’s highest-cost plants in order to reduce its overall costs to about the 41st percentile of the industry. Of course, the rest of the industry is cutting costs, too, and I doubt that this is Alcoa’s last word on capacity reductions.
If Alcoa announces 2 cents a share, will that be a market-moving earnings beat? How about 9 cents a share before restructuring charges? Or will the comparison with the 21 cents of the fourth quarter of 2010 rule the day? And how many analysts and pundits will go back to that number to see what it included and left out? (Just for the record, the fourth-quarter 2010 number was adjusted down by 3 cents from 24 cents a share to eliminate a special benefit. But the number looked especially good that quarter because the fourth quarter of 2009 included 28 cents a share in charges.)
Alcoa’s earnings are a microcosm for fourth-quarter 2011 earnings as a whole.
Right now, Wall Street analysts are looking for an 11.6% year-over-year increase in earnings for the Standard & Poor’s 500 stocks. Analysts have been busy all quarter cutting estimates from the original call of 18.8% earnings growth for the period.
This reduction to 11.6% growth, of course, sets up one of Wall Street’s favorite games of lowering expectations so companies can beat them. A whopping 75% of the companies that have issued guidance for the fourth quarter have lowered earnings projections.
And earnings are likely to be even more volatile than usual. So much that lowered projection of 11.6% earnings growth depends on just one sector, financials, and within that sector on just one stock, American International Group
Right now, analysts are looking for a 75% jump in earnings for the financial sector. As we all know, financial sector earnings are especially subject to accounting gimmicks. Last quarter, for example, financial companies showed big gains from an accounting rule that allows them to consider the drop in the price of their bonds -- the ones they’ve issued and not what they hold -- as a gain. I’d expect we might see something similar again this quarter.
Add that to whatever gains banks can generate from reducing the amount they’ve put aside for bad loans and you’ve got a formula for a potential increase in earnings that has virtually nothing to do with the long-term profitability of the sector.
But the financial sector earnings season gets even wackier when you break down the figures and note that much of that 75% improvement in earnings is due to just one company. AIG is expected to show a profit of 61 cents a share after reporting a loss of $16.20 a share in the last quarter of 2010.
Think about all this if Wall Street starts trying to convince you that it’s time to build an investment strategy on fourth-quarter earnings numbers.
At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did not own shares of Alcoa or American International Group as of the end of September. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here.