Caution On Better-Than-Expected Earnings, Because Projections Keep Getting Lowered

Posted by Bigtrends on August 5, 2016 3:07 PM

Earnings beats are concealing bad results
S&P 500 earnings are still 'poor', even if they are better than expected

by Tomi Kilgore

Investors shouldn’t be fooled by this season’s “better-than-expected” earnings—they are still pretty bad.

With nearly 90% of the S&P 500 companies having reported second-quarter results through Friday morning (437 out of 505), aggregate earnings-per-share for the group are on course to decline 3.5% from a year ago, according to FactSet.

Many Wall Street strategists are pleased, because that is a lot better than expectations of a 5.5% decline on June 30, just before earnings reporting season kicked off. So are investors, as the S&P SPX, +0.74% (SPX) (SPY) and Nasdaq Composite Index COMP, +1.03%  rallied into record territory, and the Dow Jones Industrial Average DJIA, +0.89% (DIA) was less than 0.5% away, in afternoon trade Friday. Read more in Market Snapshot.

But that is like saying you should be happy with the “D” you got, because it would really be a “B” if the teacher changed the scale to grade on a curve.

MW-ET300_SPX_EP_20160805134802_NS

“The beat on earnings is due at least in part to negative earnings revisions heading into earnings season, similar to what we have seen for the last 29 quarters with aggregate upside to expectations,” Morgan Stanley equity strategists wrote in a recent note to clients.

Earnings might be beating lowered expectations, but they are still worse than the aggregate FactSet consensus of a 3.1% decline at the end of the first quarter on March 31. It also means S&P 500 earnings will suffer the fifth-straight quarter of year-over-year declines, the longest such streak since the five-quarter stretch from the third quarter of 2008 through the third quarter of 2009, the heart of the Great Recession.

John Stoltzfus, chief investment strategist at Oppenheimer & Co., said he believes companies dampen expectations through the quarter, causing analysts to cut their estimates based on company guidance. “Companies then report figures that surprise to the upside,” Stoltzfus wrote in a recent research note.

Index/sector # of companies reported % of companies reported Blended EPS growth (%) Growth estimate as of March 31
S&P 500 437 86.5 -3.5 -3.1
Consumer discretionary 58 66.7 10.7 9.5
Consumer Staples 27 75.0 -0.7 -1.9
Energy 37 100.0 -82.4 -76.8
Financials 90 97.8 -4.2 -1.2
Health care 49 86.0 4.9 2.9
Industrials 65 95.6 -4.0 -5.1
Information technology 55 80.9 -1.5 -0.5
Materials 26 96.3 -8.9 -10.7
Telecommunication services 5 100 7.2 11.4
Utilities 25 89.3 6.5 4.7
FactSet

Priceline Group Inc. PCLN, +3.68% (PCLN)which has beat earnings-per-share estimates for at least 26 straight quarters, provides a perfect example of this strategy.

The online travel services company reported late Thursday adjusted second-quarter EPS of $13.93, well above the FactSet consensus of $12.67. The stock jumped 4.7% in afternoon trade to a nine-month high.

But when the company reported first-quarter results on May 3, it guided second-quarter EPS to a range of $11.60 to $12.50, compared with the FactSet consensus at the time of $14.96. That marked the ninth out of 10 quarterly reports that Priceline warned of a miss.

Don’t miss: Priceline investors are being fooled again.

So even though earnings beat lowered expectations by a wide margin, they still fell short of original estimates—a “D” that turned into a “B” after changing the grading scale. Sound familiar?

Similarly, Viacom Inc. VIAB, +0.53%  (VIAB) warned in June of an earnings miss, because of the poor performance of its latest “Teenage Mutant Ninja Turtles” movie. On Thursday, Viacom beat EPS forecasts, with the company hailing the movie as a saving grace.

MW-ET302_EPSgro_20160805142902_NS

How much longer will investors reward companies that have rigged the game to make it easier to win? Recent stock performance data suggests changes may have already started.

Through Friday, the shares of companies that have beat second-quarter earnings expectations have increased by an average of 1.0% two days before the earnings release through two days after the release, according to data provided by John Butters, a senior earnings analyst at FactSet.

“This percentage is below the five-year average price increase of 1.2% during this same window for companies reporting upside earnings surprises,” Butters wrote in a research note.

Goldman Sachs strategists turned bearish on U.S. stocks on a three-month view this week, saying they “remain expensive and earnings growth is poor.”

Courtesy of marketwatch.com

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