The 4th quarter earnings season is more than halfway done. We now have 312, or 62.4%, of the S&P 500 reports in. However, the early reporting firms tend to be a bit bigger and more profitable than the stragglers, and those 312 firms actually represent 75.3% of the total expected net income.
That, of course, presupposes that all the remaining firms report exactly as expected, which is unlikely. But it shouldn’t be too far off as those 206 firms also represented 74.9% of all the net income a year ago.
The reports are encouraging, with total net income for those firms rising 29.3% over a year ago. The early median surprise of 4.39% is also fairly strong, although the ratio of positive to negative surprises is only somewhat above normal at just 3.42. The total net income growth of the reporting firms is a slight slowdown from the 32.2% growth those same firms posted in the third quarter.
Big Profits Report Early
It seems the higher growers reported early. The expectations are that the remaining 188 firms will post total net income that is 26.9% higher than a year ago. That is a big acceleration from the year-over-year growth of the third quarter of 7.47%. It now looks like the final year-over-year growth will be 28.7%, up from the implied level of 25.8% as of last week.
Given that positive earnings surprises almost always outnumber disappointments, that number implies that the remaining firms would have a median surprise of 0.00 and a surprise ratio of 1.00, which is also highly unlikely. Thus growth will be close to 30% when all is said and done for the quarter. At the very start of earnings season, the expected growth was under 20%.
Revenues Expected Lighter
Revenue growth though is expected to slow down significantly, actually falling 1.74%, down from positive growth of 8.18% those 188 firms reported in the third quarter. On the other hand, revenue growth among those that have reported is very healthy at 8.50%, actually higher than the 8.12% growth those 312 firms reported in the third quarter.
Looking ahead to the first quarter, though, those firms are expected to post year-over-year revenue growth of just 5.12%. If the Financials are excluded, reported revenue growth is 8.98%, up from 8.39% in the third quarter, and slowing to 5.31% in the first quarter. Tougher year-over-year comparisons are a bigger part of the story. However, as I mentioned above, revenue surprises have been quite strong so far, with a median revenue surprise of 1.44%.
Net Margin Expansion
Thus, the stellar earnings growth is mostly due to the continued expansion of net margins. Much of the year over year margin expansion is due to the Financials, were the whole concept of revenues is a bit different from most companies, and thus the concept of net margins is also a bit different.
Much of the earnings growth in the Financials has come from firms setting aside less for bad debts than they did last year. One should be a bit on the doubtful side about the quality of those earnings, particularly in the absence of mark to market accounting.
Among those that have reported, net margins are 9.79%, or 8.69% if one excludes the Financials, up from 8.22% (7.85% excluding Financials) a year ago, but down from 10.01% (8.71% excluding Financials) in the third quarter. The expected net margin for the remainder is 7.18% (6.53% excluding Financials) up from 5.56% (6.45% ex-Financials) last year.
Net margins continue to march northward on a yearly basis. In 2008, overall net margins were just 5.88%, rising to 6.42% in 2009. They are expected to hit 8.73% in 2010 and continue climbing to 9.48% in 2011 and 10.12% in 2012. The pattern is a bit different, particularly during the recession if the Financials are excluded, as margins fell from 7.78% in 2008 to 7.13% in 2009, but have started a robust recovery and are expected to be 8.23% in 2010, 8.76% in 2011 and 9.35% in 2012.
A Look Ahead to Fiscal 2011 & Beyond
The expectations for the full year are very healthy, with total net income for 2010 expected to rise to $785.3 billion in 2010, up from $544.3 billion in 2009. In 2011, the total net income for the S&P 500 should be $901.7 billion, or increases of 43.7% and 14.8%, respectively.
The early expectation is for 2012 to have total net income passing the $1 Trillion mark to $1.0113 Trillion. That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $106.79. That is up from $57.71 for 2009, $82.93 for 2010, and $95.20 for 2011. In an environment where the 10-year T-note is yielding 3.63%, a P/E of 15.8x based on 2010 and 13.7x based on 2011 earnings looks attractive. The P/E based on 2012 earnings is 12.2x.
With almost two 2011 estimates being raised for each one being cut (revisions ratio of 1.88), one has to feel confident that the current expectations for 2011 will be hit, and more likely exceeded. Analysts are raising their 2012 projections at almost the same rate, with a revisions ratio of 1.83. While a lot can happen between now and the time the 2012 earnings are all in, upward estimate momentum means that the current 2012 earnings are more likely to be exceeded than for them to fall short.
This provides a strong fundamental backing for the market to continue to move higher. The bullish argument is further boosted by such historical factors such as being in the third year of the presidential cycle (almost always the best of the four) and having a Democrat in the White House and the GOP at least partially in charge at the other end of Pennsylvania Ave. While there is not a huge sample size of years with that political alignment, those that exist were very good ones for the stock market.
A Few Caveats
On the other hand there is a very real prospect of total political gridlock, which would greatly raise uncertainty about governmental policy and the strength of the economy that could undermine confidence. As Shakespeare said: “Beware the ides of March.” That is approximately when the U.S. will hit its current debt ceiling.
If it is not raised, the U.S. government could go into at least a technical default on its debt, and the government would probably have to shut down (not immediately as there are a few games that can be played, but if it were to last for more than a few weeks, shutdown and default is likely). That is hardly something that will inspire confidence in the markets.
While it is inconceivable that it will not eventually be passed, it is an opportunity for major political theater, and there is a chance that there will be a delay between the debt ceiling being hit and when it gets raised.
The economy does seem to have made a slow turn towards recovery. However, job creation remains very sluggish. That is particularly true if one goes by the establishment survey, which has shown only 157,000 jobs created over the last two months. The household survey has been much more upbeat, showing growth of 414,000 jobs over the same period, and the largest two month drop in the unemployment rate since 1958.
Most of the real growth in the economy has come from higher productivity, not more hours being worked. Those productivity gains are accruing to capital, not labor. That was seen again in the fourth quarter productivity report where productivity rose at 2.6% while unit labor costs dropped 0.6%. This is a major reason behind the rising net margins, and resulting strong earnings growth.
Record Levels by Mid-Next Year?
Companies are expected to continue growing their earnings nicely, and the 14.8% expected growth for 2011, if achieved, means that the total earnings for the S&P 500 should hit a new record by the middle of next year. Solid growth of 12.2% is expected to continue into 2012. With analysts, on balance, raising estimates for 2011 and 2012, increases the odds that that growth will be achieved.
Growth of 14.8% is not exactly awful. Even on the revenue side the expected growth in 2011 of 5.75%, or 9.33% if one excludes the Financial sector is very solid. Clearly the analytical community is not expecting the economy to turn south again.
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