Earnings & Reactions: CostCo versus Alcoa

We’ve been watching the firm bid under the market with detached amusement. The liquidity-driven rally is now firmly detached from the fundamentals, and will likely continue that until the Mid-Term elections are over.

A reader suggests that recent market headlines remind him of the Chicago Cubs:

Ace Pitcher Prior Strikes Out 18! 

But then you read further down into the article: But Cubs still lose 2-1. (If Cubs fans can wait for over 50 years, then we can only guess how long the markets will stay irrational for).

Let’s look at the earnings picture more closely: Dow component Alcoa missing badly on softening demand for metals (Gee, what might that mean to the economy?), markets looked past a miss by a major bellwhether and a key economic indicator to focus on Pepsi and CostCo.

Consider: Pepsi 3Q Profit Rises was the headlines; But deeper into the report, we learn that the profit increase was in comparison with last year’s results, depressed by a large tax charge. Similarly,  Domino’s Earnings Rose 21% headline was primarily based on European  growth; In the U.S., the company saw a decline in sales, with same store sales off 3.1%. (What slow down?)

Meanwhile, despite all the hoopla over technology and semiconductors, Chip companies have been warning left and right. Both Intel and AMD expect revenues to be down 14% from a year ago.  On the warnings, the SMHs have been rallying.

But the biggest earnings goof was Costco — earnings rose a paltry 1% in Q4. The headlines trumpeted the beat ("Costco earnings up unexpectedly") — but then we read on: The company only recently lowered expectation for Q3 & 4, as sales have softened. Their unexpected beat-the-number was based on 3 items 1) a one time tax benefit; 2) lower-than-expected worker’s compensation costs; and (my favorite) 3) Unexpectedly profitible gasoline sales in the last week of the quarter

I am not at all suggesting that earnings are god-awful — they still look to be up double digits on a year-over-year basis. But this quarter saw more preannouncements, more misses, more reduced guidance than prior quarters. Its exactly what you should expect for a slowing economy.

There is not a whole lot of room for any misses. The S&P500 trades
at 18 times trailing earnings; The Russell 2000 is 35 times.
Bellwhether General Electric (reporting soon after I write this) trades
at nearly 23 times earnings. Even if earnings come in as consensus,
this market ain’t cheap

If you think earnings are the basis for this rally, then you have not been paying attention. The rally we are witnessing is not fundamentally driven, nor is it forecasting an economic soft landing. It is a liquidity driven effort that I do not expect to last until year’s end.

Happy Friday the 13th . . .


Next week, we will hear from Intel, IBM and Yahoo on Tuesday;  Apple, eBay and JPMorgan on Wednesday,  Honeywell on Thursday, and 3M on Friday.


UPDATE: October 13, 2006 7:12am

I am trying to get a handle on GE’s earnings today (49 cents share consensus), which has been reported as 48 cents, a one penny miss. But the original headline I saw said 49 cents.

The WSJ writes:

The Fairfield, Conn., conglomerate posted third-quarter net income of $4.96 billion, or 48 cents a share, from $4.68 billion, or 44 cents a share, in the year-earlier period.

CNN is reporting 49 cents per share:

The diversified conglomerate, the No. 2 company in the world in market value, earned net income of $5.1 billion, or 49 cents a share, in the period, up from $4.6 billion, or 43 cents a share, in the year-earlier period. Analysts surveyed by earnings tracker First Call had forecast earnings per share of 49 cents.

I haven’t drilled down yet, and I will be away from the screen for a while, so if anyone can clarify this, please do so in comments.

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Discussions found on the web:
  1. john commented on Oct 13

    from marketwatch:
    GE’s third-quarter net income rose to $4.96 billion, or 48 cents a share, from $4.68 billion, or 44 cents, earned in the year-earlier period. GE said it earned 49 cents a share from continuing operations after a $100 million loss for discontinued operations at its insurance businesses, some of which are being held for sale

  2. Mark commented on Oct 13

    So it misses but if you take out a certain loss well then it met expectations!

  3. Barry Ritholtz commented on Oct 13

    Earnings ex-expenses!

    It never ends . . .

  4. DD commented on Oct 13

    General Electric Co. (GE) Friday said third-quarter net income rose 6% to
    $4.96 billion, or 48 cents a share, from $4.68 billion, or 44 cents a share,
    in the year-earlier period.
    The Fairfield, Conn., diversified industrial manufacturer said earnings from
    continuing operations rose to 49 cents a share, matching the average analyst
    estimate from a survey by Thomson First Call.
    GE said revenue in the three months ended Sept. 30, rose 12% to $40.86
    billion from $36.37 billion.
    Analysts forecast revenue of $39.77 billion, on average.
    The company forecast 2006 earnings of $1.97 to $1.99 a share, surrounding
    the average analyst estimate of $1.98 a share.

  5. DD commented on Oct 13

    Loss from discontinued operations was $0.1 billion for the quarter and included
    adjustments related to the Genworth and GE Insurance Solutions dispositions, and
    the results of GE Life, which is in the process of being sold. Accordingly,
    third-quarter 2006 net EPS were $.48, up 9% from the third quarter of 2005.

  6. DD commented on Oct 13

    all of their organic growth is coming from overseas…

  7. blam commented on Oct 13

    I wouldn’t call the futures and stock markets irrational. We are just witnessing the culmination of 10 years of financial crime aided by the most corrupt government and monetary agency the US has seen since Nixon.

  8. cygnus commented on Oct 13

    It was the same thing with McDonalds, increased demand in europe.

  9. Mark commented on Oct 13

    I am beginning to think that the overseas growth is going to sufficiently cushion these multinationals in the event of any downturn domestically. Rush into mega cap Dow 30 is consistent with this as defensive/offensive maneuvre.

  10. lurker commented on Oct 13

    Mark-could it also be a weak dollar play? Foreign profits are in other currencies after all.

  11. V L commented on Oct 13

    GE has released two set of numbers:

    Real Numbers: They have missed by a penny.
    Net EPS is 0.48 (this is the bottom line)

    For those who needs to spin the news:
    Please use hypothetical “if” and “could” numbers (a.k.a. earnings from continuing operations) EPS of 0.49

  12. andiron commented on Oct 13

    i think lots of blame goes to 10 yr treasury that plunged from 5.25 in july….there is the glut argument ,but in my mind it doesn’t add up. Treasuries have to be strightened up before market behaviour can be rationalised. This also goes to creepy foreign market performance like russia, india where bubble will burst like never seen before…Dubai real estate market is more bubbly that california..what will this collapse do to all commodities? I tremble to even think..

  13. Paul Hickey commented on Oct 13

    If you need to use Alcoa as an example of why you think the economy and market are in trouble, you may want to revisit your thesis. Alcoa is down nearly 50% since 2001, while at the same time Aluminum is up almost 100%. I find it difficult to use these guys as a reliable gauge of the economy.

  14. Gary commented on Oct 13

    The market is now in the window for a decline into the 4 year cycle low. This election/liquidity drive rally has established a very well defined trend line for the last 3 months. I’m guessing once that trend line is broken we will start down into the cycle low. In past markets that were advancing as this one is, the decline has lasted 2-3 months and averaged about 20-25% down. At some point in the future the market will wake up and realize the emperor has no clothes, same as they did in 2000. Unfortunately it usually takes people 3 tries before they learn their lesson. So I expect we will go through this all over again in 2010.

  15. DD commented on Oct 13

    This also goes to creepy foreign market performance like russia, india where bubble will burst like never seen before — ??

    these ppl have all of our cash…and they are not giving it back…sorry….

  16. ca commented on Oct 13

    Barry —

    Rather than ending at the election, is it possible that this rally continues until the end of the year due to mutual fund managers chasing performance?

  17. Mike_in_Fl commented on Oct 13

    Off topic slightly, but remember those posts I had about bonds earlier? About how they were in a wildly overbought condition and how 10-year large spec longs were the highest in history — more than TWICE the previous record? Well, I posited that they were vulnerable to anything less than news of economic Armageddon. And the latest news is really putting the longs on the defensive.

    Here’s a post from my blog, which you can also read at

    Longer term, I’m not incredibly bullish or bearish on bonds. But I think the risk is that prices fall and rates rise in the shorter-term more than people expect. The “core” import price data was NOT market friendly, as you can see below …

    This morning, we got key retail sales and import/export price data for September. At first, bonds loved the fact headline import prices plunged 2.1% MOM between Aug. and Sept. Advance retail sales also dropped 0.4% vs. expectations for a 0.2% gain. BUT if you strip out ALL fuel data (we all know energy prices tanked in September), things get interesting.

    Ex-fuels monthly import inflation was 0.3% in Sept. That matches August’s 0.3% rise … giving us a 2.9% YOY ex-fuel inflation rate. Ex-auto, ex-gas retail sales were also up big 0.8%, the strongest reading since at least March, and maybe more. The reason headline sales were poor was that sales at gas stations tanked.

    Bonds shot up 11/32 in price right after the news came out. They’re now DOWN 12/32. Keep a very close eye on the bonds and how stocks react. Falling rates and assumptions of falling inflation have fueled this big market rally. While I believe the drop in energy prices WILL keep inflation from getting way out of control, these figures show the economy may not be as weak as everyone believed. They also raise the possibility core inflation will remain hot enough to concern the Fed.

  18. wcw commented on Oct 13

    All I can say, when vols are this low and you see the market moving up on bad news, you want a few cheap, short-dated index calls. They’re tax-advantaged (60% of any gain is “long-term” even when, like the Octobers, they expire in less than a week) and they’re a cheap hedge against missing out on continued index moves.

    If not for my October calls, my account would be looking pretty sorry right now.

  19. joe commented on Oct 13

    You guys are too funny, whether GE earned .48 or .49 has zero bearing on anything. If you want to take anything away from the report, listen to the call. To me, the points of interest were the strength across the board in infrastructure and the weakness in plastics. Infrastructure, particularly overseas, is going to be a driver for years to come. Plastics is getting killed by commodity prices and the fact that it’s becoming more commoditized.

    Also, GE’s balance sheet is worth digging into. If you separate the operating businesses from the finance business, the operating businesses appear on track to earn about $19-$20B in operating income and carry about 11B in debt. Obviously the finance operation is leveraged, but it appears that GE has all the financial flexibility in the world which will greatly help them in the US recession to come.

  20. Barry Ritholtz commented on Oct 13


    That is very consistent with my belief you can do better buying Asia than US stocks. Look at tETFs for Jappan, S.Korea and Australia, all feeders for China

  21. GRL commented on Oct 13

    For “bubblre of the week,” I nominate dividend paying stocks.

    In reits, check out WRE, which, with a forward annual dividend of $1.65, at a recent $41.65, yields a whopping 3.96%. Per Yahoo, trailing 5 year average yield is 5.1%, which sounds about right.

    Then there is MO, which, with a forward annual dividend of $3.44, at a recent $70.20, yields all of 4.34%. Per Yahoo, trailing 5 year average yield is 4.8%. Keep in mind, this is post Schwab, so the price has been knocked down some from a recent high of ~ $85.00. If not for Schwab litigation risk, the yeild would be more like 4.04%.

    For a case of massive overvaluation, there is ASN, an apartment reit. Traditionally this one yielded around 6.2%, but at a recent $58.36, with a forward dividend of $1.74, that comes to a massively puny 2.98%, which doesn’t even keep up with “inflation ex-inflation.”

    Then there are business development corporations like ACAS and ALD, all yielding in the 8% range. These are in line with 5 year averages, but, keep in mind these are not tax-advantaged, and a few months ago they were yielding around 9-10%.

    I could go on, but you get the picture. I don’t understand why this is happening. It is great to get capital gains, but it is going to kill my long-term returns.

    I pray every day for these stock prices to go DOWN, but it does no good.

  22. Chris commented on Oct 13

    There is an interesting conversation going on at Minyanville.com right now where Bernie Schaeffer is saying that he thinks the S&P rallies 15% between now and the end of the year. Sounds like a pipe dream to me but the argument is persuasive, any thoughs BR?


  23. S commented on Oct 13

    DPZ bought back $145,000,000 worth of its stock during the first three quarters of the year. Until they file the 10Q, we won’t know the average purchase price, but an educated guess suggests they bought back about 6%-8% of their stock oustanding.

    If companies can organically grow operating earnings 6%, then buy back 6% of their stock, they’ve manufactured EPS growth of 12%.

    Financial alchemy when the economy grows 2%.

  24. bondguy commented on Oct 13

    Question for the people who argue that the retail sales number was strong: Ok I understand that with falling fuel prices retail sales fell and that consumption spending increased but how come the overall level of retails sales is down from August. In otherwords if the consumer spent less on gas last month they did not spend all of those “savings” on consumer goods. So overall spending was down, does it matter massively what the composition of the spending was? It looks as if the consumer “saved” part of their energy windfall. Anyway less money was forked over to retailers in September than in August. Any thoughts are welcome. I enjoy all the thoughtful post on this site.

  25. Wayne S. commented on Oct 13

    I checked Russell 2000 PE’s and the median PE per telecharts is 18.20 – I cannot vouch for data, can’t quantify median vs average, but still barely half the 35X Barry mentions. And 35X just SOUNDS too high.

    But 18.20x is pretty high anyway and this late in the cycle with inverted yield curve…..I’m out and watching (cursing) on the sidelines.

  26. kennycan commented on Oct 13

    bondguy – perhaps the reset on their mortgage ate up all their energy savings.

  27. ph commented on May 31

    What does everyone think about GE selling their Plastics division to Sabic for $11.6 billion? GE is making about $1.5 billion in the process, and makes me wonder if the sum of the parts is more lucrative than the whole.

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