Even a “superstorm,” it seems, was unable to dampen fourth quarter profits to the extent that gloomy pundits had suggested in the closing weeks of 2012.
With the reporting season moving into the home stretch, the rate at which companies are reporting earnings that beat analysts’ forecasts remains high. As of Tuesday, according to Thomson Reuters, 70 percent of the 353 companies to report earnings beat expectations, slightly better than the 65 percent average in the last four quarters and well above the long-term average of 62 percent.
Cisco Systems (NASDAQ: CSCO) was the latest blue chip to top analysts' consensus projections, earning $2.7 billion on $12.1 billion in sales for its fiscal second quarter. Companies that had been expected to add greater drag, like property and casualty insurers such as Chubb Corp. (NYSE: CB), have also fared better than analysts and investors had expected. That doesn’t mean the results were worthy of fireworks, of course. But analysts now estimate that fourth-quarter earnings for the S&P 500 grew at a rate of 5.3 percent, up from 1.9 percent as of the start of the season.
True, some of the companies still due to report their fourth-quarter results are in sectors where the disappointment rates have been higher, such as materials stocks (half of all companies have fallen short of expectations, and some 25 percent of the companies in the group have yet to report their results), the industrials sector and the consumer discretionary space.
Remember, though, that a positive surprise isn’t the same thing as earnings growth, and it hasn’t suddenly become easier for companies to post bottom-line growth. Indeed, many of those that have announced an increase in profits have done so in spite of the fact that revenues have stayed flat, fallen or risen only infinitesimally. There is reason to be confident that the third quarter did indeed mark the trough for earnings growth, but not to bet on a big rebound in that growth.
What useful insight can investors glean from all these percentages?
Firstly, it’s increasingly clear what sectors are facing headwinds and which ones will benefit from tailwinds. Verizon Communications (NYSE: VZ) is struggling and has proved to be a drag on the telecom services group – but even without its dismal showing, the other companies in the small sector wouldn’t have done much better. It may not matter much that another telecom business beats expectations when those expectations were for a double-digit decline in profitability. Meanwhile, the financials stocks clearly are doing far better than expected, although investors should keep a keen eye open for signs that the mortgage refinancing wave that has contributed to some of this surprising earnings growth may not last for long, and look for other businesses that will step in to replace it as a growth engine for banking profits.
Secondly, the wave of earnings reports provide a reminder to keep an eye open for positive earnings surprises that are combined with earnings growth (or at least, a turnaround or recovery) and some kind of better news on the revenue front as well. That trifecta is what is likely to prove most resilient in the coming quarters.
Curiously, as Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch, reminded clients in a note published Monday, fourth-quarter earnings disappointments have been punished less than they have been historically. Unsurprisingly, though, technology stocks have been most heavily punished for any shortfall in earnings; certainly, the market’s response to Apple’s (NASDAQ: AAPL) modest decline in profitability may be overshadowing this broader trend.
Subramanian doesn’t offer a hypothesis for this trend, but there are several reasonable possibilities: The economic backdrop appears to many more stable and perhaps even improving slightly. S&P 500 stocks still trade, on average, below the historic average of about 15 times earnings; in spite of the market’s big gains throughout January, many investors may well view stocks as being reasonably valued and more prone to see “disappointing” companies as offering some upside potential.
Subramanian also points out that the cyclical parts of the market are doing better than the defensive ones. Technology, energy and financial stocks have provided the largest “beats” on both earnings and revenue, and all six cyclical sectors of the S&P 500 have seen their earnings outlook lifted since the reporting season began. That, Subramanian suggests, means multinational stocks are the best place for investors to place their bets for 2013.
With more than 120 of the S&P 500 companies left to report their fourth quarter results as of Wednesday night, there is still plenty of room for disappointments, larger-than-expected losses and certainly for a change in the market’s psychology that would prompt a selloff of some kind. But in that event, it’s important to remember that an earnings release simply confirms what has already happened. What matters more is what a CEO or chief financial officer has to say in the ritual conference call with analysts. That’s where you’ll learn whether what triggered a disappointing earnings release was an anomaly or the beginning of a worrying new trend.
In the absence of 20-20 foresight, sometimes prudent reactions to earnings news can boil down to reading between the lines in these conference calls and grasping the nuances of what management says, or fails to say, about the company’s prospects.