Analyzing Expectations

2/23/2015


Earnings season often acts as a catalyst for share-price action over the next few months. Even a novice investor comes to realize that a company's actual results matter less than how those results compare to Wall Street's expectations. 

So far, the fourth quarter is trending above historical norms, with 70% of S&P 500 Index companies exceeding the consensus earnings-per-share estimate, versus the average of 64% since 2000. Roughly 78% of companies in the index have reported quarterly results.

Results look better when the bar companies need to clear is lowered over the course of a quarter. In 15 straight quarters, S&P 500 profit estimates declined from the beginning of the quarter to its close, anywhere from two to seven percentage points. And every time, the S&P 500 Index exceeded those lowered expectations. Interestingly, actual profits topped the original estimate — the one from the start of the quarter — only four times.

Per-share profits, of course, are just one component of quarterly results. Sales, profit margins, backlog, management's comments on business prospects, and guidance for future quarters — among other factors — also play significant roles in determining a stock's reaction.

Executives often sandbag their guidance to temper the expectations of notoriously bullish analysts, which can lead to lower targets for both the company guiding and firms in similar situations. This predictable dance continued during the latest earnings season. Stocks entered the March quarter with analysts projecting 5% higher per-share earnings for the S&P 500 Index, according to Thomson Reuters. That target may have already seemed conservative, given the consensus for 12% growth on Oct. 1. But today the consensus calls for a 2% decline on weakness in the energy and utilities sectors, along with executives' warnings regarding the impact of the stronger U.S. dollar.

Profit estimates for the June and September quarters are also down sharply since Jan. 1. The consensus projects 2% higher earnings for full-year 2015, below the 8% estimated at the beginning of the year.


Our earnings season scorecard

Most of our recommended stocks have fared well in the latest earnings season, with 30 of 36 stocks having reported (two have since been downgraded).

So far, median growth for earnings per share is 19%, with 28 companies posting gains. Median sales growth is 10%, again with 28 companies reporting higher sales.

A total of 22 stocks topped consensus profit estimates. the same number beat on sales. Most importantly, 19 of the 29 stocks outperformed the S&P 500 Index on the first day of trading after the report.


In the following paragraphs, we review five stocks that outperformed the S&P 500 after delivering impressive December-quarter results.

Jones Lang LaSalle ($162; JLL) shares have rallied 12% since the company topped consensus estimates for both earnings per share and revenue in the December quarter. Jones Lang delivered broad sales growth, with real-estate services up 15% and the investment-management unit up 39%. Despite currency headwinds, Jones Lang grew revenue 14% in the Asia-Pacific region and 13% in Europe, the Middle East, and Africa. Cash from operations climbed 17%, marking the fifth straight quarter of growth.

Analysts' 2015 profit estimates for Jones Lang have steadily drifted higher in the past 90 days to reflect the improving commercial real estate market. Jones Lang used excess cash to reduce its total debt by more than 50% in the second half of 2014. That decline in leverage has emboldened management to pursue acquisitions, expected to account for 55% of discretionary spending this year. Jones Lang LaSalle is a Focus List Buy and a Long-Term Buy.


In the December quarter, Lear ($109; LEA), an auto-parts supplier, grew per-share earnings 47%, sales 7%, and cash flow 35%. Lear reaffirmed its 2015 guidance, with revenue projected to climb 4% to 7%. About half of that growth should be organic, with the remainder coming from the $850 million acquisition of leather supplier Eagle Ottawa, completed on Jan. 5. The Eagle Ottawa deal should also boost profit margins at the seating unit.

Lear's stock is up 10% since its December-quarter report. Shares could get an additional jolt if Lear moves forward with an investor proposal to split its car-seat (75% of 2014 sales, 57% of earnings) and electrical-parts (25%, 43%) businesses into two publicly traded companies. For now, the stock remains attractively priced at 13 times trailing earnings, a 26% discount to the median for S&P 1500 auto parts and equipment stocks. Lear, earning a Value rank of 92, is a Focus List Buy and a Long-Term Buy.


ManpowerGroup ($78; MAN) posted meager growth in the December quarter. Yet its shares rallied because investors had braced for much worse from the employment agency that draws on Europe for 78% of revenue. The stock still has its warts. The Overall rank is just 67, depressed by dreadful scores for Momentum (21) and Earnings Estimates (6). Operating cash flow fell 31% in the second half of 2014, and the company's per-share profits and revenue are projected to shrink in 2015.

But a lot of pessimism is already priced into the stock. Based on the most bearish analyst estimate for 2015 profits, the stock's forward P/E ratio is 16. In contrast, the median S&P 1500 human-resources stock trades at 21 times the year-ahead consensus. Europe appears to be in its initial stages of recovery, and Manpower expects business in France (26% of revenue last year) to improve in the March quarter. The stock is a Buy and a Long-Term Buy.


Shares of Shire ($238; SHPG) surged 7% on Feb. 12 after the company reported December-quarter results. Per-share profits missed the consensus by a nickel but still grew 17% to $2.63 excluding special items. Total revenue advanced 19% to $1.58 billion, slightly ahead of analysts' expectations. Operating cash flow quadrupled to $2.55 billion, largely due to the $1.64 billion break-up fee Shire collected from AbbVie ($59; ABBV) after their merger fell apart. Excluding that fee, Shire's cash from operations jumped an impressive 51%.

In anticipation of stiff currency headwinds in the year ahead, management says per-share profits should rise at mid-single-digit rates in 2015, compared to the consensus target of 8% growth at the time of the announcement. The stock's big reaction to the report may have reflected relief that Shire's drug-pipeline growth prospects remain solid. Shire also raised its semiannual dividend 13% to $0.5727 per share, payable April 14. Shire is a Focus List Buy and a Long-Term Buy.


Rising analysts estimates call for Southwest Airlines' ($44; LUV) earnings per share to more than triple in the March quarter and soar 75% higher in 2015. Several factors should contribute to that growth, including rising capacity, strong demand, and fairly stable airfares. However, none are more important than the sharp decline in oil prices.

Fuel represented 32% of Southwest's operating costs last year, down from its five-year average of 35%. Lower fuel costs helped Southwest's returns on investment and equity reach their highest levels since 1999. In anticipation of continued soft oil prices, Southwest scrapped its 2015 fuel hedges in January. Prior to discontinuing those hedges, Southwest had projected fuel costs of $1.95 to $2.05 per gallon this year, which would be its lowest rate since 2007 and represent about $1.7 billion in savings from 2014. Southwest, earning an Overall score of 97, is a Long-Term Buy.

TOP FORECASTS SURPRISERS
The recommended stocks below truly surprised investors this earnings season, as illustrated by their shares outperforming the S&P 500 by more than one percentage point in the first full day of trading after releasing their reports. We track quarterly results for all buy-rated stocks on our website. Click on the Earnings Announcements link in the Research Center section of the Subscriber Area home page.
EPS
Date
1-Day
Stock
Price
% Chg.
Stock
% Chg.
Versus
S&P
500
---- Actual ----
% Change
Surprise %
Est. EPS,
Current
Quarter
($)
Est. EPS,
Current
Qtr. – 30
Days Ago
($)
Est. EPS,
Change,
Current
Quarter
(%)
Company (Price; Ticker)
EPS
($)
Sales
($Mil.)
EPS
(%)
Sales
(%)
EPS
(%)
Sales
(%)
Alaska Air ($64; ALK)
1/22/15
4.6
2.4
0.9
1,306
69
8
0
1
1.22
1.08
91
Apple ($129; AAPL)
1/27/15
5.7
7.1
3.1
74,599
48
30
18
10
2.09
2.01
26
Cognizant Technology
($61; CTSH)
2/4/15
5.0
5.3
0.7
2,742
26
16
3
3
0.69
0.70
12
Corning ($25; GLW)
1/27/15
3.4
4.0
0.5
2,404
55
30
18
4
0.33
0.35
8
CVS Health ($104; CVS)
2/10/15
2.1
1.7
1.2
37,055
8
13
1
3
1.08
1.09
6
Google ($543; GOOGL)
1/29/15
4.7
6.7
6.9
18,103
15
15
(3)
(2)
6.66
6.89
6
Jones Lang LaSalle
($162; JLL)
2/3/15
10.3
8.4
4.3
1,749
29
16
12
4
0.52
0.62
32
Lear ($109; LEA)
1/30/15
1.3
3.3
2.3
4,550
47
7
10
1
2.19
2.22
19
ManpowerGroup
($78; MAN)
1/30/15
12.3
14.3
1.5
5,121
18
(3)
3
0
0.79
0.88
(8)
Nvidia ($22; NVDA)
2/11/15
7.2
6.2
0.4
1,251
79
9
48
4
0.33
0.31
15
Schlumberger ($88; SLB)
1/15/15
6.1
4.4
1.5
12,641
11
6
3
(1)
1.14
1.17
(6)
Skyworks Solutions
($83; SWKS)
1/22/15
1.9
2.2
1.3
806
88
59
6
4
1.12
1.03
81
Shire ($238; SHPG)
2/12/15
7.1
6.1
2.6
1,576
17
19
(2)
2
2.64
2.68
12
Southwest Airlines
($44; LUV)
1/22/15
8.4
6.3
0.6
4,628
79
5
7
1
0.65
0.51
261
U.S. Bancorp ($45; USB)
1/21/15
2.4
2.7
0.8
5,472
4
6
3
3
0.76
0.76
4
Union Pacific ($123; UNP)
1/22/15
4.7
2.6
1.6
6,153
26
9
7
1
1.46
1.41
22

 


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