CHICAGO, Sept. 13, 2011 /PRNewswire/ -- Zacks Research Equity Strategist, Dirk Van Dijk says that S&P 500 earnings are continuing to show red ink. He tracks companies on the Zacks.com web site, naming names, while forecasting trends for the months ahead.
Expectations Starting to Fall
Second quarter earnings season is effectively over with 499 or 99.8% of S&P 500 reports in. With the exception of a handful of financials, most notably Bank of America (NYSE: BAC), which had a $12 billion negative swing in net income from last year, this is another great earnings season.
The year-over-year growth rate for the S&P 500 is 11.9%, way off the 17.1% pace those same 499 firms posted in the first quarter. However, it you exclude the Financial sector, growth is 19.3%, actually up slightly from the 19.1% pace of the first quarter. At the beginning of earnings season, growth of 9.7% was expected; 12.2% ex-Financials.
Attention will now start to shift to the expected growth in the third quarter. Things are expected to slow a bit, with 12.0% growth expected overall, and 11.7% if the financials are excluded. While that is down fairly significantly from the second quarter, especially ex-financials, it is roughly in-line with what the expectations for the second quarter were before companies started to report.
Top-line results were also very strong, with 10.00% year-over-year growth for the 499, actually up from the 8.84% growth they posted in the first quarter. The top-line results are even more impressive if the financials are excluded, rising to 10.32% from the 9.58% pace of the first quarter.
Top-line surprises have been almost as good as than the bottom-line surprises, with a median surprise of 1.80% and a 2.48 surprise ratio. The revenue growth in the first half is remarkable, given only 0.4% GDP growth in the first quarter and just 1.0% in the second, with low overall inflation. High commodity prices helped revenues among the Energy and Materials sectors, and higher growth abroad and currency translation effects from a weak dollar have also helped.
Looking ahead to the third quarter, year-over-year growth of 5.85% is expected for the full S&P 500, and 6.04% growth if financials are excluded. At the very start of reporting season, revenue growth of 9.62% total growth was expected, and 8.94% excluding the financials.
Net Margins Growing but Slowing
Net margins have been one of the keys to earnings growth, but cracks in the story are starting to appear. The 499 that have reported have net margins of 9.17%, up from 9.10% a year ago. That, however, is due to the financials, especially BAC. Excluding financials, next margins have come in at 8.53%, up from 7.95% a year ago. In the third quarter, overall net margins are expected to expand to 9.67%, and 8.56% excluding the financials.
On an annual basis, net margins continue to march northward. In 2008, overall net margins were just 5.88%, rising to 6.37% in 2009. They hit 8.62% in 2010 and are expected to continue climbing to 9.27% in 2011 and 9.69% in 2012. The pattern is a bit different, particularly during the recession, if the financials are excluded, as margins fell from 7.78% in 2008 to 7.04% in 2009, but have started a robust recovery and rose to 8.23% in 2010. They are expected to rise to 8.77% in 2011 and 9.11% in 2012.
Full-Year Expectations - And Beyond
The expectations for the full year are very healthy, with total net income for 2010 rising to $793.0 billion in 2010, up from $543.6 billion in 2009. In 2011, the total net income for the S&P 500 should be $916.1 billion, or increases of 45.9% and 15.5%, respectively. The expectation is for 2012 to have total net income passing the $1 Trillion mark to $1.009 Trillion, for growth of 9.4%.
That will also put the "EPS" for the S&P 500 over the $100 "per share" level for the first time at $105.79. That is up from $56.90 for 2009, $83.12 for 2010 and $96.02 for 2011. In an environment where the 10-year T-note is yielding 1.92%, a P/E of 14.3x based on 2010 and 12.4x based on 2011 earnings looks attractive. The P/E based on 2012 earnings is 11.2x. Those P/Es are based on the Thursday close, so are even lower after Friday's fall.
Estimate Revisions Slowing
Estimate revisions activity has past its seasonal peak. During the last seasonal decline in revisions activity, the ratio of increases to cuts also declined sharply, from over 2.0 at the height of the last earnings season, but dropped sharply after earnings season was over. It is happening again. The revisions ratio for 2011 dropped to 0.65, which is a bearish reading, and for 2012, it is down to a very bearish reading of 0.42.
The number of estimate increases has plunged, as many of the increases that came right on the heels of earnings beats are now over 4 weeks old, and very few new estimate increases are being made. This is a less worrisome situation than if the revisions ratios were plunging due to a flood of new estimate cuts, but it can hardly be considered a good sign.
The numbers are also confirmed by the ratio of firms with rising mean estimates to those with falling mean estimated dropping to 0.71 for 2011 and 0.41 for 2012. Given the weakness in the economy, and the reduced economic forecasts for 2012, the lack of estimate increases, and the relative abundance of estimate cuts is not exactly shocking. Still, it is an important thing to keep an eye on.
Recap of Key Data and Events of Last Week
It was a relatively light week for economic data. While it is hard to call the numbers we got "strong," at least they were generally better than expected.
The ISM non-manufacturing (or service) survey actually rose to 53.3 from 52.7, much better than the expected drop to 51.0. That means that the service sector of the economy actually expanded faster in August than in July, but still not what would call robust growth. Still, it is a positive.
That comes on top of the ISM manufacturing survey the week before, which also surprised to the upside, although it fell to 50.6 from 50.9, meaning very slow -- but still positive -- growth and much better than the expected level of 48.5. With both measures above the magic 50 mark, it is very unlikely that we are currently in a double dip, but there is not a lot of margin for error.
The best news of the week came from a sharp drop in the Trade Deficit, to $44.81 billion in July from a downwardly revised $51.57 billion in June. Most of the decline was due to lower oil prices as the oil deficit dropped to $25.6 billion from $29.4 billion. The non-oil goods deficit also fell, to $34.08 billion from $36.58 billion.
The surplus we run in Services expanded slightly to $15.82 billion from $15.46 billion. The decline is extremely welcome, but the level of the trade deficit is an ongoing national disaster. It is the trade deficit -- not the budget deficit -- that is responsible for our being deeply in debt to the rest of the world, most notably China. The trade deficit lowers the level of GDP on essentially a dollar-for-dollar basis.
The reduced drag from the trade deficit, if it continues in August and September, is one thing that could well cause GDP growth to be higher in the third quarter than it was in the second. Getting rid of the trade deficit is probably the single most promising path to a restoration of prosperity, and resolving global economic imbalances.
For that to happen, two things need to occur: The dollar will have to become significantly weaker against all other major currencies and we have to find a way to end our addiction to foreign oil. Unfortunately, the governments and central banks of the other major currencies have a vote on the value of the dollar, and every president since Nixon has promised to end our oil addiction, with no success.
Initial claims for jobless benefits rose again, to 414,000. Remaining above the 400,000 is not a good sign. That is the level that would indicate that the economy is producing enough jobs on balance to start to bring down the unemployment rate.
The major "event" of the week was Obama's speech of jobs. He proposed a $447 billion stimulus package to get the economy moving again. Not all of that is incremental spending over what is being spent this year, but it does prevent the cutbacks that were scheduled to happen at the end of this year.
The biggest part of the program was an extension and expansion of the payroll tax cut. In 2011, the individual side was cut to 4.2% from 6.2% and for 2012 he is proposing that it come down to 3.2%, and that the employer side also be cut. I'm not sure how much the cut on the employer side will cause them to increase employment, especially since it only lasts for a year, but at the margin it should help. The typical worker will get about $1,500 more in their pocket to spend than they would if the program were allowed to expire, and $500 more than they had in 2011.
Since the payroll tax ends for earnings over $106,800, the maximum after-tax spending boost from the cut will be $3,204, or $1,068 more in 2012 than 2011. The incremental spending power in people's pockets should help increase demand, and thus put people back to work. There were also parts of the program designed to help State and Local governments avoid having to lay off teachers, cops and fire fighters, as well as significant public works programs. The details of how this would be paid for are due out this week.
The program is pretty much of a textbook answer as to what to do when the economy is in a deep slump. Here is a passage from Lord Maynard Keynes that sort of illustrates where the program is coming from:
"If it is impracticable materially to increase investment, obviously there is no means of securing a higher level of employment except by increasing consumption...Moreover, I should readily concede that the wisest course is to advance on both fronts at once. Whilst aiming at a socially controlled rate of investment with a view to a progressive decline in the marginal efficiency of capital, I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume.
"There is room, therefore, for both policies to operate together — to promote investment and, at the same time, to promote consumption, not merely to the level which with the existing propensity to consume would correspond to the increased investment, but to a higher level still."
The General Theory of Employment, Interest and Money
If the program were to be passed, it should, based on some back-of-the-envelope-type calculations result in economic growth of between 1% and 2% more than it would have been. That should be more than enough to avoid a double dip. It might lead to significant progress on bringing down unemployment. I don't think it would be enough to get us down to anything like full employment, but might shave a full percentage point or more off the current 9.1% rate.
The program was more ambitious and larger than I was expecting. The details of how it will be paid for could be very significant, as they would have the potential to offset the good that the program would do. However, in one very important sense, it really doesn't matter. It is highly unlikely that this can pass Congress, particularly the House.
The speech is best seen as the opening of the 2012 re-election campaign. One thing I would have liked to have seen in the program that was not there is a crash program to start to use cheap, abundant, and domestic natural gas as a transportation fuel. That is the single most promising path towards ending our oil addiction.
At the micro level, earnings and valuations, provide plenty of reason to be bullish. This is particularly true when one looks at the prevailing level of interest rates. Currently, 242 S&P 500 (48.4%) firms have dividend yields higher than the Friday yield on the 10-year T-note (1.91%), and over two thirds (345, or 69.0%) yield more than the five year note (0.80%). Heck, 104 or 20.8% yield more than even the 30 year bond (3.25%).
Keep in mind that 114 or 22.8% of the S&P 500 stocks pay no dividend at all, so no matter how far the market falls, they will still have a 0.0% dividend yield. Many of those companies, such as Apple (Nasdaq: AAPL) with its $76 billion cash hoard, could easily pay a dividend if they wanted to. Of the 386 dividend-paying stocks, 62.7% yield more than the 10-year and 89.3% yield more than the five year. Those sorts of numbers have not been seen since the early 1950's.
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Contact: Dirk Van Dijk, CFA
SOURCE Zacks Investment Research, Inc.