We just have 23, or 4.6%, of the S&P 500 firms reporting “third quarter” earnings so far, so it is way to early draw any firm conclusions about how the quarter is shaping up. The year-over-year growth rate for the S&P 500 is 8.6%, way off the 21.0% pace those same 23 firms posted in the second quarter. Of far more importance are the expectations for the 477 who have yet to report.
Growth for them is expected to slow just slightly, to 9.5% over the third quarter of 2010, down from 10.6% year over year growth in the second quarter. However, the second quarter was distorted by some big hits to the financial sector. If we exclude the financials, growth in the third quarter is expected to slow to 12.1% year over year from 20.1%. Then again, at the beginning of second quarter earnings season, growth of 9.7% was expected; 12.2% ex-financials.
We will need another season where positive earnings surprises far outpace disappointments if we are going to match the second quarter growth rate. On the top line, growth is also expected to slow sharply, to 5.15% in total from 11.05% in the second quarter, and excluding the financials to 9.16% from 13.27%.
Net Margin Expansion
Expanding net margins have been one of the keys to earnings growth. In the second quarter, total net margins were 9.14%, and excluding financials they were 9.13%, up from 9.10% and 7.95 ex-financials in the second quarter of 2010 (all 500 companies reported).
In the third quarter the financials net margins are expected to recover (we will see about that, depends on the level of net charge-offs at the banks, which are sort of hard to predict). Thus, total net margins are expected (for the 477) to rise to 9.13%, while excluding financials they are expected to drop to 8.96%.
On an annual basis, net margins continue to march northward. In 2008, overall net margins were just 5.88%, rising to 6.37% in 2009. They hit 8.65% in 2010 and are expected to continue climbing to 9.22% in 2011 and 9.68% in 2012.
The pattern is a bit different, particularly during the recession. If the financials are excluded, margins fell from 7.78% in 2008 to 7.04% in 2009, but started a robust recovery and rose to 8.27% in 2010. They are expected to rise to 8.76% in 2011 and 9.13% in 2012.
Full-Year Expectations
The expectations for the full year are very healthy, with total net income for 2010 rising to $795.6 billion in 2010, up from $543.4 billion in 2009. In 2011, the total net income for the S&P 500 should be $910.9 billion, or increases of 46.4% and 14.5%, respectively. The expectation is for 2012 to have total net income passing the $1 Trillion mark to $1.004 Trillion, for growth of 10.2%.
That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $105.21. That is up from $56.97 for 2009, $83.42 for 2010, and $95.51 for 2011. In an environment where the 10-year T-note is yielding 1.92%, a P/E of 13.9x based on 2010 and 12.2x based on 2011 earnings looks attractive. The P/E based on 2012 earnings is just 11.0x.
Revisions Activity to Pick Up
Estimate revisions activity is passing its seasonal low. What has really been drying up is estimate increases, as those made immediately after the second quarter positive earnings surprise roll off the four-week moving total that I track. The number of cuts has also declined, but not nearly as sharply and as a result the ratio of increases to cuts is now at a very bearish level of 0.47 for 2011 and just 0.34 for 2012.
If those ratios stay in that area when total revision activity heats up (as it will dramatically over the next month or so) it will be a reason for very serious concern. The net cuts are very widespread, the ratio of firms with rising mean estimates to falling is down to 0.49 for this year and to 0.38 for next year, and almost every sector has more cuts than increases for both this year and next.
In light of the generally downbeat economic news, it is not surprising that we are not seeing a lot of estimate increases without the catalyst of positive earnings surprises. During slow revisions periods, the revisions ratio is generally less significant that during periods of high activity, but that does not mean that it should be ignored completely, and it is flashing a yellow caution light pretty brightly now.
The strong earnings performance we have seen, particularly in large multinational company earnings (like most of the S&P 500 I track in this report), is the single most important argument in the bulls’ favor (along with the low valuations based on those earnings). Thus, if that starts to crack in a big way, it is a very big concern.
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