"In the fourth quarter, 63% of S&P 500 companies beat analyst earnings estimates." What does that statement mean? Does it imply that being above the 50% line is a good showing for the still-embattled corporate America, and that investors should put on risk trades today and head for the golf course?
Or does it mean that, since the end of the recession, fewer companies managed to leap over consensus forecasts than evidenced in prior quarters -- and that we should tread lightly into earnings season? I have no clue. The statement does not go far enough in explaining why -- despite a respectable gross domestic product print -- companies failed to blow the doors off with respect to their fourth-quarters earnings and the initial crack at fiscal year guidance. Let's look at some of the figures.
At the core, I believe profit margins were weak to round out 2011, with companies harmed by the lagging nature of commodity price run-ups from earlier in the year (see consumer discretionary and staples sectors). In my view, the aforementioned 63% beat score was of poor quality, influenced by such things as share-buyback activity -- as in Wal-Mart's (WMT) reduction of its diluted share count -- and unsustainable shenanigans on employee-related costs.
So, yes, a debate is ongoing as to whether the market has fully captured trailing earnings into valuations, However, I would counter that with a question. Why assign a higher multiple to a future in which past bottom-line growth is arguably unsustainable? After all, costs are coming back online, the U.S. is caught in a below-trend GDP range and distribution channels in the Eurozone remain mired in a deep slump. Everything happens for a reason (or so said the high school girl to her freshly dumped high school boy) and there are reasons for the trailing S&P 500 price-to-earnings multiple of 14.6x -- which is south of the 16.4x average built up since 1954. Oh yeah, remember that little thing on an income statement known as revenue?
During the fourth-quarter earnings season, almost every corner I peered into revealed revenue shortfalls -- and not by flash-in-the-pan companies that trade their American depositary receipts (ADRs) here in the U.S. We are talking about global businesses, the buzzy names that frequently command outsized investor attention in an earnings season.
Global exposure is supposed to be an undying benefit for a company, but the top-line softness told me that, for the near-term, the opposite will be true. For multinationals, the slow wave of eurozone contagion, coupled with periphery countries suffering sustained fiscal troubles, appeared to have increasingly crept into the earnings picture of multinationals. (There is this odd disconnect between the flow of news and when it begins to surface in corporate financials.)
Here are a couple added tidbits:
• The dollar plunged from January 2011 to approximately May 2011, so dollar comparisons for many companies are unfavorable as far as first-quarter revenue is concerned.
• China macro trends are not as ebullient as they were last year, with policymakers having put a foot on the brakes when it comes to growth.
• Strength in revenue is a must for bringing leverage over higher costs and operating expenses. February import prices rose for the first time in three months due to fuel, and fuel expenses generally correlate with potential trouble for companies.
The market did not take very well to revenue shortfalls vs. analyst expectations. Negative initial reactions in the stock prices, and subsequent rebounds, have me wondering if the market is set up for another knife-in-the-back moment as the first quarter closes.
Inside Edge: Off-the-Beaten Path Trends to Watch
Poor brands, reawakening stock prices: Two names -- Skechers (SKX) and Best Buy (BBY) -- continue to march higher absent any known news. For companies such as these, with outdated business models or products and depressed share valuations, I get interested when the stock begins perking up. In this case, I'm more intrigued by Best Buy than I am by Skechers.
Push-and-pull assessment of volatility: Bulls are saying a sub-20 CBOE Market Volatility Index (VIX) will cause fearful, and often late, retail investors to dive into the market. Bears believe the market has gotten too complacent and is underpricing risks to forward earnings. Count me in the latter camp for now.
Small-caps: The iShares Russell 2000 (IWM) has traded in a tight range since February. (Remember, just a few weeks back, that the Russell was called a red flag as it toted behind the broad market's rise?) On Monday, the IWM approached its July 2011 high, only to pull back. There seems to be stiff resistance at around $86, and perhaps this is an indication of the resistance felt inside domestic companies as they try to push through ticket price increases to compensate for elevated costs.
Either way, be aware of both the economic implications -- as well as the fact that, both times the IWM hovered around current levels in 2011, the IWM fell in response.