Pfizer, Merck, Eaton, Cummins and Time Warner are part of Zacks Earnings Preview

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Jul 29, 2013, 09:30 ET

CHICAGO, July 29, 2013 /PRNewswire/ -- Zacks.com releases the list of companies likely to issue earnings surprises. This week's list includes Pfizer (NYSE:PFE-Free Report),Merck (NYSE:MRK-Free Report),Eaton Corp (NYSE:ETN-Free Report), Cummins (NYSE:CMI-Free Report), Time Warner (NYSE:TWX-Free Report).

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Grading the Q2 Earnings Season

We have crossed the halfway mark in the Q2 earnings season – with results from 262 S&P 500 companies, accounting for 59.3% of the index's total market capitalization, already out (as of Friday, July 26th). In other words, while there are still plenty of reports to come, we have seen roughly two-thirds of Q2 earnings already.

This week brings in results from 808 companies, including 125 S&P 500 members. This includes operators likePfizer (NYSE:PFE-Free Report),Merck (NYSE:MRK-Free Report),Eaton Corp (NYSE:ETN-Free Report), Cummins (NYSE:CMI-Free Report), Time Warner (NYSE:TWX-Free Report), and many others. By the end of this week, we will have seen Q2 earnings reports from 77% of the S&P 500 members.

We have seen enough Q2 earnings reports by now to be able to judge it with a fair amount of confidence. So what is the judgment then?

Looking at the aggregate growth rates, beat ratios, and median surprises, the Q2 earnings season isn't materially different from what we saw in Q1 and over the last few earnings seasons. While we had graded the Q1 earnings season as between 'average' and 'below average', the Q2 earnings season appears to be tracking better than Q1 on the revenue beat ratio.

Before buying into the not-so-bad earnings narrative, we should keep in mind that strong numbers from the Finance sector are playing an outsized role in giving respectability to the aggregate earnings data. One could dispute the legitimacy of the strength in Finance earnings given the not-so-small contribution of reserve releases to bank earnings.

But even keeping this issue aside, there is no dispute about the broad weakness outside of the Finance sector. Given this broad-based growth weakness, I would give the Q2 earnings season a 'below average' grade, even though total earnings for the quarter will likely reach a new all-time record.

The Q2 Earnings Scorecard

Total earnings for these 262 companies are up +3.7%, with 65.3% beating earnings expectations and a median surprise of +2.5%. On the revenue side, we have a growth rate of +3.6% and 51.9% are coming ahead of top-line expectations with a median surprise of +0.2%.

The earnings growth rate of +3.7% compares to +2.5% earnings growth rate in Q1 and the 4-quarter average growth pace of +3.8% for the same set of 262 companies. The earnings beat ratio, however, is tracking lower– 65.3% in Q2 vs. 68.3% in Q1 and the 4-quarter average of 66.5%. On the revenue side, the growth of +3.6% compares to +3% in Q1 and the 4-quarter average of +3.1% for this group of 262 companies. The revenue beat ratio of 51.9%, however, is decidedly better than what we saw in Q1 (42%) and the 4-quarter average (46.1%).

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Since 1988, the Zacks Rank has proven that "Earnings estimate revisions are the most powerful force impacting stock prices." Since inception in 1988, #1 Rank stocks have generated an average annual return of +28%. During the 2000-2002 bear market, Zacks #1 Rank stocks gained +43.8%, while the S&P 500 tumbled -37.6%. Also note that the Zacks Rank system has just as many Strong Sell recommendations (Rank #5) as Strong Buy recommendations (Rank #1). Since 1988, Zacks Rank #5 stocks have significantly underperformed the S&P 500 (+3% versus +10%). Thus, the Zacks Rank system allows investors to truly manage portfolio trading effectively.

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