Profit-Estimate Trends Tough To Read

10/14/2013


Earnings season is upon us, with U.S. corporate profits expected to notch another all-time record. Yet investors should not necessarily expect a smooth ride.

S&P 500 Index companies reporting September-quarter earnings have issued 94 negative preannouncements, up from 91 in the year-earlier period, according to Thomson Reuters. Only 18 have issued positive preannouncements, down from 21. At 5.2-to-1, the ratio of negative-to-positive preannouncements is more than double the norm since 1995.

However, the tone ahead of June-quarter earnings was even more discouraging, and the S&P 500 rallied to an all-time high in that reporting period. At this point last quarter, the negative-to-positive ratio was 6.5-to-1.

Per-share-profit estimates for the S&P 500 Index now call for modest 4.3% growth in the September quarter, down from a forecast of 8.5% on July 1. In the June quarter, S&P 500 earnings rose 4.9%, below the estimate of 6.1% on April 1.

Reported profit growth often falls short of initial targets. Analysts routinely trim their forecasts during a quarter, partly in response to negative preannouncements. Notably, the decline in S&P 500 earnings estimates over the last three months was less severe than five and 10-year averages, according to research firm FactSet.

The Forecasts' growth-at-a-good-price approach hinges on our ability to find reasonably valued stocks with the potential to exceed expectations. To that end, we dissected the broad S&P 1500 Index to find attractive sectors and industries. Among our findings:

Earnings-surprise trends. Based on March- and June-quarter results for the 10 broad market sectors, only health care and technology have posted two consecutive quarters of positive surprises that outstripped the average of S&P 1500 stocks. Across 24 narrowly defined industry groups, standouts for recent surprises include household products, insurance, consumer durables, and automobiles & equipment. Groups with the lowest percentage of surprises include transportation, materials, and telecom services.

Revision trends for September-quarter earnings. Over the last three months, sectors seeing the largest percentage of stocks with positive revisions include financials and energy. Top groups are insurance (64% have positive revisions, with a median increase of 1.7%), autos & equipment (53%, 1.2%), and banks (54%, 0.5%). The two worst industries are household products (0%, -8.9%) and telecom services (21%, -3.6%). 

Revision trends for December-quarter earnings. Financials and consumer staples boast the largest percentage of stocks with upward revisions. Groups showing the best revisions include autos & equipment (73%, 2.2%), banks (60%, 0.6%), and food & beverage (51%, 0.1%). Transportation (30%, -2.2%) and retailing (30%, -1.5%) are the cellar dwellers.

Recent share-price trends. The average S&P 1500 stock has rallied 6.1% since the start of the September quarter, paced by a 10.9% average gain for energy stocks and 8.8% increase for technology. Top-performing groups include food & staples retailing (14.0%), autos & equipment (11.0%), and pharmaceuticals (10.8%).

Top picks. Among recommended stocks, high-potential picks in attractive industries and sectors include Lear ($71; LEA) and Magna International ($82; MGA) in autos & equipment; Continental Resources ($109; CLR) and Whiting Petroleum ($62; WLL) in energy; Celgene ($149; CELG) in drugs; and Alliance Data Systems ($216; ADS) in technology.

SECTOR REVISIONS AND SURPRISES
The table below shows how 10 broad sectors stack up for earnings revisions and recent profit surprises, based on S&P 1500 Index stocks. Percentages in bold are above the average for all stocks in the S&P 1500. Sectors that look particularly attractive include financials and health care, while telecom services and materials offer limited appeal.
% Of Stocks With Positive Revisions,
------------------ Last 3 Months ------------------
% With Positive
----- EPS Surprises -----
Sept.
Quarter
(%)
Dec.
Quarter
(%)
Current
Year
(%)
Next
Year
(%)
June
Quarter
(%)
March
Quarter
(%)
Consumer Discretionary
35
41
53
54
62
69
Consumer Staples
29
46
39
45
63
66
Energy
42
43
47
39
60
58
Financials
49
49
63
62
66
60
Health Care
34
41
57
49
64
62
Industrials
31
42
48
47
63
56
Technology
35
35
47
47
67
65
Materials
23
30
30
23
52
51
Telecom Services
21
33
15
31
57
50
Utilities
34
41
56
58
63
57
S&P 1500
36
41
51
49
63
61

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