EARNINGS ROUNDUP: SETTING THE STAGE FOR A FOURTH QUARTER PROFITS RECOVERY

Source ; Greg Harrison
November 19th, 2012

Analysts have trimmed their earnings outlooks so much that, they have set the stage for a return to respectable levels of earnings growth in the fourth quarter, especially among Consumer Discretionary stocks.

After S&P 500 companies reported third-quarter earnings that were largely flat over year-earlier levels, investors are looking forward to seeing a return to more normal level of earnings growth – and hoping that this will show up in the fourth quarter reports. Certainly, analysts are more optimistic about the final quarter of 2012 than they were about the third quarter, and currently are calling for fourth quarter profits to grow by 4.7%. Still, that’s half of what they were forecasting S&P 500 companies would earn this quarter only a month ago, so it’s worth pondering whether they will continue to cut estimates as we head toward the end of the quarter and the year as a whole.
The most recent decline in earnings appears to be a direct result of the guidance that companies themselves provided as they released their third-quarter results. As is evident from Exhibit 1, below, until companies began publishing negative guidance, the consensus estimate for fourth-quarter earnings growth hovered just below 10%. And since most of the guidance provided by S&P 500 companies this quarter has been negative, with 3.4 bearish preannouncements for every one that was positive, the result has been a slide in earnings growth forecasts. Still, as analysts lowered their estimates, companies began to shift toward positive preannouncements. The pattern in the third quarter was similar, as an unusually negative level of preannouncements caused the growth estimate to drop to the point that the number of earnings “beats” came close to what we are used to seeing in a typical earnings season. That caused the earnings growth rate to climb once more, and served as a sign that, at their current levels, analysts’ opinions are close to the internal forecasts of the companies themselves.

The recent increase in the proportion of guidance that offers an upbeat forecast is a good sign for investors who hope that the fourth quarter will mark a resumption of earnings growth. In a typical quarter, there are 2.3 negative preannouncements for each positive one. The more bearish ratio for the fourth quarter may be daunting on an overall basis, but when we turn our attention to individual sectors, there are some encouraging signs. In the Consumer Discretionary group, for instance, there are only 2 negative preannouncements for every positive one, and five of the six companies to have published a more optimistic outlook has done so quite recently – within the last two weeks. The negative to positive ratio for the fourth quarter is more negative, at 3.2. These companies also boast the strongest earnings growth record for the third quarter and appear likely to replicate that feat in the fourth quarter.
Within the Consumer Discretionary sector, positive preannouncements have come from brands like Leggett & Platt Inc (LEG.N) and Fossil Incorporated (FOSL.O) and smaller retailers like Dollar Tree Inc (DLTR.O) and GameStop Corp (GME.N). At the other end of the spectrum, however, some household names within the retailing sector are still warning that analysts’ estimates for their fourth-quarter are still too high. This group includes Macy’s Inc (M.N), Kohl’s Corp (KSS.N), and Target Corporation (TGT.N), which all have issued negative guidance over the past two weeks.
One reason to be wary about the magnitude of any earnings rebound in the fourth quarter is what is taking place in the Materials sector. After profits growth plunged 26.6% during the third quarter, analysts currently expect earnings for the group to rise by 2.2% this quarter. That turnaround is a major factor in the overall predictions of a growth in earnings overall – but companies are cautioning analysts about being overly optimistic: while five companies have published negative guidance, only one has suggested that earnings will beat expectations. This is a relatively small sample size when compared to other S&P 500 sectors, but it still makes up a significant portion of the Materials group.

With the improvement in analyst sentiment with respect to fourth-quarter earnings growth rates, it is reasonable to hope that this will lead to a stabilization in fourth-quarter earnings estimates, as well, after a month of consistent cuts by analysts. These analysts finally may have lowered estimates to the point where companies will be able to meet or exceed expectations, laying the foundation for a return to earnings growth after a weak third quarter.

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