Preseason Earnings Offer Some Room for Optimism
It’s a tug-of-war, with analysts being resolutely bearish when it comes to forecast second-quarter corporate profits, while early-reporting companies in the “preseason” have offered up better-than-expected results.
Alcoa (AA.N) kicked off the earnings season for the second quarter of 2012 with rather gloomy news. True, on an operating basis, the company’s profits from continuing operations performed very slightly better than analysts had anticipated. But in spite of that “positive surprise”, the picture painted by Alcoa’s results was a gloomy one: with aluminum prices down 18% from year-ago levels, leaving it with a loss of $2 million and generating 0 – yes, zero – cents per share of either earnings or losses for its investors. Granted, Alcoa is one of those companies likely to bear the brunt of the selloff in commodities since early this year, but the company’s results appear to some market pundits to reflect the kind of headwinds that companies throughout the S&P 500 faced during the quarter.
For more insight into what the second quarter’s earnings season might have in store for investors, we turn to the “preseason” period, ahead of Alcoa’s release. A total of 25 companies reported their results prior to the unofficial beginning of earnings season, and in the wake of a quarter during which analysts have steadily trimmed the forecasts for S&P 500 earnings growth from 10% in mid-April to only 5.5% today. Add in the disproportionate impact that Bank of America’s (BAC.N) earnings are expected to have on that figure – last year’s big loss was a result of the one-time payment related to the settlement of a mortgage-backed securities lawsuit – and profits growth almost flattens out, to an estimated 0.4%. Perhaps Alcoa’s results are indeed a harbinger of tougher times? Given that earnings growth rates have slumped in the last two quarters, a further decline might not be unexpected, particularly given the growth in the level of anxiety about the impact of Europe’s sovereign debt crisis on global economic growth. Have analysts cut their forecasts enough – or should we brace ourselves for further declines?
For anyone looking for a ray of sunshine, the preseason earnings reports may provide some. Of the 25 companies that reported in the preseason, 16 announced profits that beat analysts’ consensus forecasts at the time of the announcement. This 64% beat rate is higher than the long term average of 62%, although it is lower than the 68% rate over the last four quarters. More encouragement: our research has shown that nearly 70% of the time, the full earnings season’s results follow the trend set during the preseason. This means that when companies beat (or miss) at a higher than average rate in the preseason, the remaining companies are likely to do so as well. Although the 64% rate is still fairly close to the average, it is higher, so there is at least a sporting chance that earnings will turn out to be somewhat better than anticipated.
Moreover, those companies that beat their second-quarter earnings estimates in the preseason period did so while posting growth in profits that was significantly higher than forecast. The earnings surprise measure, or the total amount by which earnings are higher than estimates, is 5.3% so far. This is nearly double the average surprise of 2.8%, again suggesting that the quarter may be better than current expectations. As seen below, earnings surprises vary by sector, but companies in the Consumer Discretionary sector appear to be doing well, based on the large surprises announced by Lennar Corp (LEN.N), Carnival Corp (CCL.N), and Apollo Group, Inc. (APOL.O). Furthermore, these early reporters demonstrate strong earnings growth: as a group, their earnings climbed 8.2% during the second quarter, comparing very favorably to the 0.4% estimate (ex-Bank of America) for the overall growth estimate.
Still, there remain reasons for anxiety. For instance, using StarMine SmartEstimates, which place the greatest weight on the most recent forecasts and the most accurate analysts, we can see (as outlined in the chart below) that seven of the ten sectors in the S&P 500 have a negative Predicted Surprise. That signals that the aggregate SmartEstimates for these sectors are lower than the respective consensus estimates, and that there is a reasonably strong probability that either companies in those sectors will report negative earnings surprises or that analysts will cut profits growth estimates further between now and the reporting date. Two sectors, Financials and Energy, stand out from the crowd, having particularly large negative Predicted Surprises of -2.5% and -3.7%, respectively. This information strongly suggests that, even though analysts already have slashed their estimates for companies in these sectors, further decreases are likely.
Combining the information gleaned from the reports released by preseason companies with analysts’ opinions gives us a somewhat mixed view of the prospects for the second quarter. Looking only at preseason data, it would seem that there is reason to hope that the second-quarter results will be better than anticipated, even if only modestly so. But analysts see the world differently; in their view, there’s more bad news on the horizon, particularly for companies in the Financials and Energy sectors.
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