Review & Outlook

Our take on the investing, financial, & economic themes of the day

Third Quarter Earnings Update, Part I

8 November, 2011 by Ben O'Brien in Commentary

It’s easy to forget about corporate earnings in the wildly volatile market of 2011. For the time being, macroeconomic events—right now primarily the European debt crisis—are driving stock prices. In October the market’s correlation, the measure of how many stocks move in the same direction, was at the highest level since October 1987 according to a recent Bloomberg report. But earnings are still the “bottom line”, the most important factor in determining a company’s stock price in the long run. Every quarter we study the earnings reports that companies release. These reports are a sort of cross section of the economy, giving us insights into things like the behavior of consumers, corporate strategy and the effects of inflation that are not always apparent from the endless stream of economic numbers that are discussed in the media each day.

This quarter’s earnings reports show that U.S. companies remain resilient. While our economy is still just emerging from the trough of a long “U-shaped” recovery, corporate profits have bounced back from the recession with a sharply “V-shaped” rebound as companies have tightened their belts at home and tapped into faster-growing markets abroad. Companies have record high profitability, record cash levels. They are increasingly paying out dividends and buying back shares. Many are restructuring and coming up with new strategies to prosper in a time of somewhat slower growth.

Right now the third quarter earnings season, when companies report results for the three months ending September 30th, is coming to a close. How does it look? This quarter was strong but a bit more of a mixed bag than last quarter when virtually all of the major blue chip companies reported solid earnings. There were some high profile misses with companies such as Netflix, Amazon, Apple and Goldman Sachs. But for each of these headline-grabbing disappointments there were many more companies like Google, VF Corp, Intuitive Surgical, McDonalds and Chevron to name just a few of the many companies that beat expectations and posted high double-digit growth over last year.

Of the S&P 500 companies that have reported so far (about 87% of the total) around 70% beat earnings estimates, 10% matched estimates and 20% came in lower than expected. These percentages were pretty much on par with last quarter and just slightly below the average for the last five years according to Zacks Investment Research.

Perhaps more important than how many companies beat analyst estimates, though, is how much earnings grew.  Earnings of S&P 500 companies that reported so far have grown 18% over the third quarter of 2010. This is not as strong as last year’s third quarter earnings growth of 39.4%, though, this deceleration is to be expected now that we are no longer measuring earnings against recession numbers as we were last year. Earnings growth of 18% is a healthy gain, especially considering the headwinds our economy faces. The third quarter is on pace to be the eighth consecutive quarter of double-digit earnings growth.

Taking a look at full year earnings, the S&P 500 companies grew 45.3% in 2010 to 789.2 billion from $543.3 billion. For 2011 these companies are projected to earn 909.8 billion, an increase of 15.3% over last year. Next year estimates predict growth of 11.5% to a total of a little over $1 trillion.  In 2012 the average per share earnings of the S&P companies will likely top $100 for the first time.

In part two we will take a closer look and economic sectors and individual companies and discuss what these earnings reports tell us about the economy and the market.

Ben O’Brien