What Do Earnings Tell Us?

  • Bloomberg.com – U.S. Stocks Cheapest Since 1990 on Analyst Estimates
    S&P 500 companies may earn $85.96 a share in the next year, according to data from equity analysts compiled by Bloomberg. That compares with the index’s record combined profits of $89.93 a share from the prior 12 months in September 2007, when the S&P 500 was 19 percent higher than today. The earnings upgrades come as income beats Wall Street estimates at the fastest rate ever for the third time in four quarters. More than 80 percent of the 173 companies in the S&P 500 that reported results have topped estimates, compared with 79.5 percent in the third quarter and 72.3 percent in the three- month period before that, Bloomberg data show.


The article above cites some earnings numbers that need to be put into context.  First, as the next chart shows, the one-year forward estimate has grossly overestimated actual earnings in recent years.  In fact, last year saw some of the biggest misses in the history of earnings guesses.

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Second, in a recent Market Talk we pointed out that the yield curve may be the single most important factor in determining earnings for Q4, largely because of its importance in determining profits in the financial sector.

Finally, as the last chart shows, companies always beat expectations.  Even when earnings were collapsing in biblical proportions in Q4 2008, 58% of companies still beat expectations.  The last time less than 50% beat expectation was 1998!

As we note on the chart, prior to SEC regulation “FD” (aka, Fair Disclosure), roughly 50% of companies beat expectations, as would be the case if analysts were trying to get it right.  Now that companies have to disclose to all at the same time, we believe their investor relations departments are masters at “guiding” analysts just below actual earnings.  This way the companies “beat” expectations and get the positive press and accolades that come with it.  Further, it seems that everyone is happy with this apparent gaming of the system.

This is why we believe the percentage of companies that beat expectations is a meaningless statistic.  The game is designed for this to happen, even when earnings are collapsing.

<Click on chart for larger image>

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