Think Earnings Don't Matter? Goodyear Will Make You Think Again

 | Jul 28, 2017 | 5:03 PM EDT
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Earnings season is always a hectic time for those of us who depend on fundamental analysis to select stocks. According to John Butters and his excellent weekly Earnings Insight review for FactSet, 57% of the companies in the S&P 500 have reported earnings as of today. Next week is another busy week, with another 26% of the S&P 500 scheduled to report, and the bias begins to switch after Apple (AAPL) posts earnings on Tuesday.

The latter half of earnings season is always dominated by smaller companies, the segment in which I spend most of my time, as these companies do not have the huge financial staffs of the major multinationals and it takes them longer to cobble together their quarterly figures.

So, I'll be snowed under next week, and it is only through reading the work of analysts like Butters and Jim Cramer's headline pieces for Real Money that I am able to figure out the earnings zeitgeist. The second quarter has been a strong one, with earnings now expected to rise 9.1%, an estimate that is two percentage points higher than it was a week ago. That usually happens as reports are populated and "actuals" replace estimates.

Butters notes in this week's Earnings Insight that 73% of companies have exceeded revenue estimates this quarter, the highest percentage in the current economic cycle. Due to easy comparisons with the year-ago quarter's depressed prices for hydrocarbons, energy companies are leading the surprises. Butters explains that without the energy sector, the blended growth for the S&P 500 in the second quarter would be 6.8% instead of the current 9.1%.

In one of my columns for Real Money a while back I noted that if anyone tells you "earnings don't matter" you should punch that person in the mouth. That was a joke, of course -- I don't advocate violence -- but if you hear that line repeated at any time, just dial up Goodyear Tire & Rubber's (GT) second-quarter earnings release from this morning on your phone and thrust it (gently) in that person's face.

On April 28, as part of their first-quarter earnings release, Goodyear management forecast operating profit for 2017 of $2 billion. That estimate reflected a slight increase from 2016's level, seemingly a decent performance in a "peak auto" environment.

This morning GT management lowered their forecast for 2017 operating profit to $1.6 billion - $1.65 billion, a 20% decrease. Can things really change that much in three months? Well, they did.

You didn't have to have started your career as an "auto parts and tires" analyst (I did, a long time ago at a firm that no longer exists) to know that things got rotten in Akron quickly. GT shares are paying the price today.

So, quarterly earnings do matter, and a constant tweaking of earnings models is the method by which stock market efficiency is achieved. Those models are the basis for valuation of individual stocks, and one would think that such valuations would yield something like a normal distribution among the investment ratings of the Wall Street analysts who produce those estimates.

Do we have such a distribution now? Well, I'll leave it to Butters to give the figures (below), but clearly the answer is "no." So keep doing your homework on the stocks you own, and keep running quarterly numbers.

Overall, there are 11,175 ratings on stocks in the S&P 500. Of these 11,175 ratings, 49.2% are Buy ratings, 45.3% are Hold ratings, and 5.5% are Sell ratings. At the sector level, the Information Technology and Energy sectors have the highest percentage of Buy ratings at 57%, while the Utilities and Consumer Staples sectors have the highest percentages of Sell ratings at 7%.

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