Earnings Season Under Way

1/17/2011


Helped by strength in the technology and financial sectors, the averages have rallied into earnings-reporting season. Near-term action will hinge on December-quarter results and 2011 guidance, and volatility in either direction would not be surprising. But with the Dow Theory squarely in the bullish camp and quality stocks available at reasonable valuations, a constructive stance toward equities remains appropriate. For now, our buy lists have 12% to 15% in a short-term bond fund.

Better-than-consensus results

Alcoa ($16; AA) kicked off earnings season on Jan. 10, but the bulk of reports are not due until the second half of January. Consensus estimates project that profits for the S&P 500 Index will be up 32% on a 7.5% sales increase for the December quarter — the last period of easy year-to-year comparisons.

Estimate-revision trends are mostly favorable, with more analysts lifting estimates than lowering estimates over the past four weeks. December-quarter guidance from companies has also been encouraging, as the ratio of positive-to-negative profit preannouncements is somewhat better than historical norms.

Another quarter of mostly better-than-consensus results is likely. But investors have grown accustomed to positive profit surprises, and the outlooks provided for 2011 are likely to be the most important driver of stock prices. Consensus estimates project S&P 500 Index profits will be up 13.5% for 2011, and current valuations appear reasonable relative to that growth rate.

Among the S&P 500's 10 sectors, only the health-care (7.0% increase), technology (9.7% increase), and utility (0.7% decrease) sectors are expected to report 2011 profit growth of less than 10%. More encouraging, for both the March and June quarters, at least seven sectors have seen consensus estimates revised higher since Oct. 1.

Conclusion

As always, it will be the market's reaction that reveals whether results have exceeded expectations. A favorable reaction to the results would be encouraging, as it would suggest the positive outlook for year-ahead profits has not been fully discounted. The same is true for individual stocks, and subscribers should not be afraid to buy attractively valued stocks after an earnings-related rally.

December-quarter revision trends have been especially favorable in the technology sector, which continues to score well in our Quadrix rating system. Measured by the percentage of stocks with Overall scores above 80, technology ranks best by a considerable margin. Top tech picks include Apple ($342; AAPL), IBM ($147; IBM), and Texas Instruments ($34; TXN).


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