Profit Estimates Under Pressure

4/9/2012


With earnings news likely to drive trading in coming weeks, a failure to close above 5,368.93 on the Dow Transports would be discouraging on a near-term basis. Still, we are inclined to view a pullback as an opportunity, partly because profit growers are available at reasonable valuations. For now, with the Dow Theory in the bullish camp, our buy lists hold about 90% to 93% in stocks.

Downbeat guidance

Stocks head into earnings-reporting season with the Dow Industrials and Dow Transports within 9% of all-time highs, while the S&P 500 Index is about 12% from its 2007 all-time high. Yet expectations for quarterly results are fairly downbeat, with consensus estimates projecting just 3% year-to-year growth for S&P 500 Index profits.

Only four of the S&P 500's 10 sectors — consumer discretionary, financials, industrials, and technology — are expected to deliver at least 5% growth, according to Thomson Reuters. Profit declines are expected from the materials, telecom, and utility sectors, as projections for all three have deteriorated over the past three and six months.

In fact, only the financials and technology sectors have seen upward profit-estimate revisions since Jan. 1, partly because of a rash of earnings warnings for the March quarter. For S&P 500 companies, the ratio of negative-to-positive preannouncements is at a three-year high.

The discouraging guidance has had little impact on expectations for the June, September, and December quarters. Estimates for all three quarters have dipped only modestly since Jan. 1, according to Thomson Reuters, and S&P 500 Index profits for full-year 2012 are expected to be up more than 8%.

While the expectations of a speedy rebound in growth could leave the stock market vulnerable to disappointment, you can take steps to improve your odds. For the median stock on our Buy or Long-Term Buy lists, profit growth in the next quarterly release is expected to exceed 8.5%, with 10.2% growth expected in the following quarter. Yet the median Forecasts recommendation trades at roughly 12 times expected current-year earnings — lower than about 70% of U.S.-traded stocks.

Conclusion

Earnings news is likely to dominate near-term action, and a market pullback would not be surprising. But with the Dow Theory in the bullish camp and quality growers available at reasonable valuations, we are sticking with a mostly invested posture. For new buying, Intel ($28; INTC) and Macy's ($41; M) represent top picks.


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