Thursday, December 9, 2010


By Dirk Van Dijk

Key Points:

  • 3Q Earnings season effectively done — 496 or 99.2% of S&P 500 reports in so far.
  • Strong earnings season, with a median EPS surprise of 4.92%, and a 3.74 surprise ratio. While those numbers are down from earlier in the reporting season, they are still very good. Total of 355 positive surprises and just 95 disappointments. Positive year-over-year growth for 377, falling EPS for 115 firms, 3.28 ratio. 71.6% of all reporting firms do better than expected, 76.0% report positive year-over-year growth. Total net income reported up 25.3%.
  • Sales Surprise ratio at 1.52, median surprise 0.79%, 56.9% of all firms do better than expected on top line. Revenue growth healthy at 8.13%.
  • Net margins fell slightly to 9.01% from 9.02 in the second quarter but far above 7.78% year ago level. Excluding Financials, net margins rise to 8.06% from 7.91% in the second quarter and 7.00% a year ago.
  • Total net income reported is $207.8 billion, up from $165.8 billion a year ago, $203.5 billion in second quarter.
  • Full year total earnings for the S&P 500 expected to jump 42.9% in 2010, 13.9% further in 2011. Total revenues for the S&P 500 expected to rise 5.22% in 2010, 5.69% in 2011.
  • Autos, Finance, Basic Materials and Energy expected to be earnings growth leaders in 2010.? Construction expected to move from the red to the black. No sector expected to see earnings declines in 2010 or in 2011.
  • Net Margins marching higher, from 5.88% in 2008 to 6.39% in 2009 to 8.68% expected for 2010, 9.35% expected for 2011. Major source of earnings growth. Net margins ex-financials 7.79% in 2008, 7.10% in 2009, 8.22% expected for 2010, 8.63% in 2011.
  • Revisions ratio for full S&P 500 at 1.78 for 2010, at 1.47 for 2011, both bullish readings. Ratio of firms with rising to falling mean estimates at 1.55 for 2010, 1.33 for 2011, also positive readings. Total revisions activity past peak, and plunging. Changes in revisions ratios driven by estimates falling out more than by new estimates added.
  • S&P 500 earned $544.3 billion in 2009, expected to earn $777.8 billion in 2010, $886.0 billion in 2011.
  • S&P 500 earned $57.62 in 2009: $81.98 in 2010 and $93.96 in 2011 expected, bottom up. Puts P/Es at 21.2x for 2009, 14.9x for 2010 and 13.0x for 2011.
  • Top Down estimates: $80.15 for 2010, $90.54 for 2011.

A Great Season

This has been a great reporting season, especially on the bottom line. The top line also looks good especially if one excludes the financials. However, soaring net margins have been the primary driver of the earnings growth.

Analysts have responded to the better-than-expected results by raising their estimates, but much more so for 2010 than for 2011. The (relative) lack of upward revisions for 2011 might be a yellow flag. It is not that the revisions ratio for 2011 is awful, it is in bullish territory at 1.47, but that it lags well behind that of 2010 at 1.78.

We are well past the peak estimate revisions activity, which is now plunging. As a result, changes in the revisions ratios are being driven more by old estimates falling out of the four-week running total than new estimates being added. Some of the differential between 2010 and 2011 is “mechanical.” Since the third quarter is part of fiscal year 2010, if a company beats by say $0.05, an analyst has to raise his fiscal year 2010 estimate or he is implicitly cutting his forecast for the fourth quarter.

An increase for fiscal 2011 means that the analyst sees the better-than-expected results for the third quarter as being sustainable at least in the medium term. Still, the 1.47 ratio is somewhat disappointing when almost four times as many firms beat the consensus in the third quarter as disappointed.

The stellar earnings growth is mostly due to the continued expansion of net margins. Much of the year-over-year margin expansion is due to the Financials, where the whole concept of revenues is a bit different from most companies, and thus the concept of net margins is also a bit different.

However, even if the Financials are excluded, net margins continue to march northward. Earnings growth so far has been stellar at 25.3% year over year, although that is down from the over 30% levels we were seeing earlier in the reporting season. It is also a slowdown from the 37.1% year over year growth that the same firms reported in the second quarter.

The remaining four companies left to report, are unlikely to significantly change the aggregate numbers. No sector has more than one firm left to report, and we have dispensed with the “yet to report” tables this week.

Full-Year Projections Favorable

The expectations for the full year are very healthy, with total net income for 2010 expected to rise to $777.8 billion in 2010, up from $544.3 billion in 2009. In 2011, the total net income for the S&P 500 should be $886.0 billion, or increases of 42.9% and 13.9%, respectively. Translated to “EPS” for the index, that would be $57.62 for 2009, $81.98 for 2010, and 93.96 for 2011.

In an environment where the 10-year T-note is yielding just 2.99%, a P/E of 14.9x based on 2010 and 13.0x based on 2011 earnings looks attractive. Much of the $600 billion in newly created money from QE2 is likely to eventually find its way into the equity market (not directly, but eventually). Historically, the year after mid-term elections has almost always been a good one for the stock market.

Potential Pitfalls

On the other hand, there is a very real prospect of total political gridlock, which would greatly raise uncertainty about governmental policy and the strength of the economy that could undermine confidence. In the short term, the prospect of about 2 million people losing their extended unemployment benefits will act as a significant drag on the economy, as dollar for dollar, extended benefits are amongst the most effective form of economic stimulus.

The additional monetary stimulus from QE2 will help boost the economy a little bit, but that could very easily be offset by a concretionary fiscal policy. The economy needs more fiscal stimulus, not less. Unfortunately, most of the electorate is not very well schooled in macroeconomics and clearly disagreed in the last election cycle.

The theoretical danger of QE2 is that it could lead to much higher inflation, but with the massive amount of slack in the economy right now, that risk seems pretty remote. QE2 should take the risk of deflation off the table.

The economy does seemed to have made a slow turn towards recovery. However, job creation remains very sluggish. Most of the real growth in the economy has come from higher productivity, not more hours being worked. Those productivity gains are accruing to capital, not labor, and are a major reason behind the strong earnings growth. In the third quarter, the firms in the S&P 500 earned a total of $207.8 billion, up from $165.8 billion in the third quarter of 2009.

S&P 500 Earnings to Hit New High in 2011

Still, companies are expected to continue growing their earnings nicely, and the 13.9% expected growth for 2011, if achieved, means that the total earnings for the S&P 500 should hit a new record by the middle of next year. The fact that analysts are, on balance, still raising estimates for 2011 increases the odds that that growth will be achieved.

Growth of 13.9% is not exactly awful. Even on the revenue side the expected growth of 5.69%, or 7.03% if one excludes the Financial sector is still pretty solid. That should be significantly higher than U.S. nominal GDP growth in 2001. Then again, firms in the S&P 500 tend to get a significant portion of their revenues (and earnings) from overseas, and the world economy is likely to grow significantly faster than the U.S. economy in 2011. Clearly the analytical community is not expecting the economy to turn south again.

Scorecard & Earnings Surprise

  • 496 firms have reported 3Q earnings. The remaining firms are unlikely to significantly change the overall results.
  • Strong season with a median surprise of 4.92%, and a 3.74 surprise ratio (355 beats, 95 misses), 71.6% of all firms beat expectations.
  • Positive year-over-year growth for 377, falling EPS for 115 firms, 3.28 ratio; 76.0% of all firms reporting have higher EPS than last year.
  • Total net income up 25.3%. All sectors but Construction have more positive surprises than disappointments. Eight sectors have surprise ratios of 7:1 or better. Disappointments concentrated in Finance, Utility and Energy sectors.

Historically, a “normal earnings season” will have a surprise ratio of about 3:1 and a median surprise of about 3.0%. Thus, this is a positive earnings season. While the season has faded a bit from when the first firms were reporting, it still looks to be a very solid season overall.

Scorecard & Earnings Surprise 3Q Reported
Income SurprisesYr/Yr
Consumer Discretionary17.63%96.97%7.90226284
Industrial Products51.76%95.00%7.59152154
Computer and Tech45.83%100.00%5.96545609
Oils and Energy37.50%100.00%4.622313308
Business Service15.62%94.74%4.38161153
Basic Materials42.34%100.00%2.70158194
Consumer Staples5.31%97.37%2.632582412

Sales Surprises

  • Sales Surprise ratio at 1.52, median surprise 0.79%; 56.9% of all firms do better than expected on top line.
  • Growing Revenues outnumber falling revenues by ratio of 3.84; 79.0% of firms have higher revenues than a year ago.
  • Tech, Finance and Business service see widespread positive revenue surprises.
  • Revenue growth healthy at 8.13% but still greatly lags earnings growth pointing to net margin expansion (see net margin tables below).
Sales Surprises
Sales SurprisesYr/Yr
Basic Materials17.45%100.00%2.654167230
Business Service7.68%94.74%1.563144171
Computer and Tech20.33%100.00%1.5445218637
Industrial Products23.36%95.00%0.977127163
Oils and Energy16.11%100.00%0.8282315335
Consumer Discretionary3.60%96.97%0.6222012257
Consumer Staples3.68%97.37%-0.56714232511

Reported Quarterly Growth: Total Net Income

The first table shows the actual reported growth of those that have already reported (496), and excludes the four which have not yet reported.

  • The total net income is 25.3% above what was reported in the third quarter of 2009, down from 37.1% growth in the second quarter. Sequential earnings growth is 1.10%.
  • Thirteen sectors reporting showing double digit earnings growth, seven with more than 40% growth. Cyclical sectors lead the growth parade.
  • Only four sectors showing acceleration in year-over-year growth from second quarter, twelve decelerate.
Quarterly Growth: Total Net Income Reported
Income GrowthSequential Q4/Q3 ESequential Q3/Q2 AYear over Year
3Q 10 A
Year over Year
4Q 10 E
Year over Year
2Q 10 A
Industrial Products-11.25%3.28%51.76%50.85%65.22%
Computer and Tech5.46%9.11%45.83%12.25%59.65%
Basic Materials10.35%-12.87%42.34%42.94%114.14%
Oils and Energy1.35%-9.58%37.50%24.90%95.23%
Consumer Discretionary-10.69%18.96%17.63%3.96%25.37%
Business Service10.29%3.13%15.62%14.22%20.01%
Consumer Staples-10.36%7.73%5.31%-0.02%7.14%

Quarterly Growth: Total Revenues Reported

This table excludes the 4 firms that have not reported.

  • Five sectors reporting revenue growth of over 16%. Industrials and Tech in the lead, Materials, Transports and Energy also very strong.
  • Seven sectors showing growth of less than 4%.
  • S&P 500 reported Revenues up 8.1% year over year in 3Q, down from 10.7% revenue increase the same firms showed in the 2Q. This is still a very healthy level of revenue growth.
  • Slowdown to 3.37% year-over-year growth expected for fourth quarter.
Quarterly Growth: Total Revenues Reported
Sales GrowthSequential Q4/Q3 ESequential Q3/Q2 AYear over Year
3Q 10 A
Year over Year
4Q 10 E
Year over Year
2Q 09 A
Industrial Products-1.54%3.50%23.36%19.08%19.32%
Computer and Tech0.29%4.26%20.33%11.83%22.17%
Basic Materials-6.76%-0.64%17.45%11.39%18.54%
Oils and Energy4.86%1.31%16.11%16.83%27.70%
Business Service1.66%1.89%7.68%5.55%7.56%
Consumer Staples-10.22%-1.49%3.68%-2.39%7.30%
Consumer Discretionary-4.14%4.22%3.60%4.71%7.97%

Quarterly Net Margins Reported

  • This is for the 496 firms that have already reported, calculated as total net income for the sector divided by total revenues for the sector. With the vast amount of firms already having reported, these are pretty close to the final figures.
  • Net margins for S&P 500 expand to 9.01% from 7.78% a year ago, and down slightly from the 9.02% reported by these same firms in the second quarter. Net margins, ex-Financials, rise to 8.06% from 7.00% a year ago.
  • All sectors reporting year-over-year increase in margins, seven see sequential improvement.
  • Some sectors will see bigger seasonal swings in margins than others.
  • Six sectors report double-digit net margins, Tech consistent margin king.
Quarterly: Net Margins Reported
Net MarginsQ4 2010 EstimatedQ3 2010 Reported2Q 2010 Reported1Q 2010 Reported4Q 2009 Reported3Q 2009 Reported
Computer and Tech16.69%16.74%15.99%15.40%16.62%13.81%
Business Service13.55%12.89%12.74%12.41%12.52%12.01%
Consumer Staples10.76%11.84%10.82%10.61%10.51%11.65%
Consumer Discretionary8.83%10.43%9.14%8.61%8.89%9.18%
Industrial Products7.17%7.83%7.85%6.11%5.66%6.36%
Oils and Energy6.69%7.11%7.96%7.31%6.26%6.00%
Basic Materials6.89%6.27%7.15%7.39%5.37%5.18%
S&P 5008.66%9.01%9.02%8.57%7.32%7.78%
SP ex Fin’l7.82%8.06%7.91%7.46%7.27%7.00%

Annual Total Net Income Growth

  • Total S&P 500 Net Income in 2009 was 1.28% above 2008 levels, following 34.7% plunge in 2008.
  • Total earnings for the S&P 500 expected to jump 42.9% in 2010, 13.9% further in 2011.
  • Earnings recovery to happen by mid-2011, full year 2011 earnings to be 6.1% above 2007 levels. In other words, the recovery in earnings will occur far before the recovery in jobs as we are unlikely to return to 2007 job levels until mid-2015 at the earliest.
  • Autos, Finance, Basic Materials and Energy expected to be earnings growth leaders in 2010. Construction expected to move from the red to the black. No sector expected to see earnings decline in 2010 or in 2011.
  • Retail, Medical and Business Service the only sectors to post positive earnings growth in every year from 2008 through 2011.
  • All but three sectors expected to post double digit growth in 2011; cyclicals lead.
  • Twelve sectors expected to grow slower in 2011 than 2010, four expected to see growth accelerate.
Annual Total Net Income Growth
Net Income Growth2008200920102011
Construction+ to -- to -- to +305.14%
Basic Materials-4.89%-49.90%64.22%27.36%
Industrial Products6.93%-38.63%41.27%24.82%
Finance+ to -- to +323.04%20.94%
Consumer Discretionary6.25%-15.89%21.84%17.47%
Business Service27.19%1.04%14.71%15.34%
Oils and Energy20.81%-56.29%48.53%13.58%
Auto+ to -- to +2142.96%13.36%
Computer and Tech14.99%-4.24%44.90%12.71%
Consumer Staples-7.86%5.60%10.99%9.56%

Annual Total Revenue Growth

  • Total S&P 500 Revenue in 2009 6.74% below 2008 levels.
  • Total revenues for the S&P 500 expected to rise 5.22% in 2010, 5.69% in 2011.
  • Tech to lead 2010 revenue race, Energy and Industrials to take silver and bronze, but Transportation and Materials to also grow more than 13%.
  • All sectors expected to show positive top-line growth in 2011.
  • Financials the biggest drag on 2010 revenue growth, Staples and Aerospace only other sectors expected to post lower top line for the year. Revenues for Financials are notoriously flakey; low interest rates depress interest income (but also interest expense).
  • Revenue growth significantly different if Financials are excluded, down 10.46% in 2009, growth of 8.34% in 2010 and 7.03% in 2011.
  • Medical and Retail only sectors to have positive revenue growth for all three years.
  • Looking out to 2011, Energy and Industrials the only sectors expected to see double-digit revenue growth, although three other sectors expected to have revenue growth over 8%.
Annual Total Revenue Growth
Sales Growth200920102011
Oils and Energy-34.49%20.80%10.67%
Industrial Products-18.67%16.86%10.31%
Computer and Tech-6.22%22.36%7.17%
Basic Materials-19.30%14.49%6.77%
Business Service-2.35%7.42%6.28%
Consumer Discretionary-9.55%7.24%6.20%
Consumer Staples-2.13%-2.82%4.78%
S&P ex Fin’l-10.46%8.34%7.03%

Annual Net Margins

  • Net Margins marching higher, from 5.88% in 2008 to 6.39% in 2009 to 8.68% expected for 2010, 9.35% expected for 2011. Major source of earnings growth.
  • Financials significantly distort overall net margins. Net margins ex-financials 7.79% in 2008, 7.10% in 2009, 8.22% expected for 2010, 8.63% in 2011.
  • Financials net margins soar from -8.42% in 2008 to 15.37% expected for 2011.
  • Fourteen sectors seeing higher net margins in 2010 than in 2009. All sectors but Aerospace expected to post higher net margins in 2011 than in 2010.
Annual Net Margins
Net Margins2008A2009A2010E2011E
Computer and Tech12.25%12.51%14.81%15.58%
Business Service10.74%11.11%11.86%12.87%
Consumer Staples9.18%9.90%11.31%11.82%
Consumer Discretionary8.00%7.44%8.46%9.35%
Industrial Products7.51%5.67%6.85%7.75%
Oils and Energy9.10%6.07%7.47%7.66%
Basic Materials7.20%4.47%6.41%7.65%
S&P 5005.88%6.39%8.68%9.35%
S&P ex Financials7.79%7.10%8.22%8.63%

Revisions: Earnings
The Zacks Revisions Ratio: 2010

  • Revisions ratio for full S&P 500 at 2.08, up from 2.24 last week, a very bullish reading.
  • Transportation very strong, but seven other sectors have revisions ratios above 2.00.
  • Thirteen sectors with positive revisions ratios, only three below 1.0.
  • Construction and Conglomerates very weak.
  • Ratio of firms with rising to falling mean estimates at 1.89 down from 1.90 last week — still a bullish reading.
  • Total number of revisions (4 week total) up to 4,888 from 5,175 (-5.5%).
  • Increases up to 3,303 from 3,577 (-7.6%), cuts up to 1,585 from 1,598 (-0.1%).
  • Total Revisions activity passed peak. Over next six weeks plunge to less than a third of peak levels. Changes in revisions ratios will mostly be from old estimates falling out, not from new estimates being made.
The Zacks Revisions Ratio: 2010
Curr Fiscal Yr
Est – 4 wks
Industrial Products0.597935113.180.78
Computer and Tech0.432923216772.811.26
Consumer Discretionary1.51189151582.602.00
Basic Materials0.0315732152.132.14
Consumer Staples-0.24211298661.481.75
Business Service0.029617121.421.50
Oils and Energy-0.1619161241191.041.19

Revisions: Earnings
The Zacks Revisions Ratio: 2011

  • Revisions ratio for full S&P 500 at 1.47, up from 1.41 last week, still in bullish territory.
  • Six sectors have at least two increases per cut; Industrials and Transports lead, other cyclicals also strong.
  • Four sectors with negative revisions ratios (below 1.0), eleven with ratios above 1.0.
  • Ratio of firms with rising estimate to falling mean estimates at 1.33 down from 1.49; still in bullish territory.
  • Construction looks very weak for 2011; almost five cuts per increase.
  • Total number of revisions (4 week total) at 2,215, down from 4,715 (-53.0%).
  • Increases down to 1,318 from 2,758 (-52.2%) cuts fall to 897 from 1,957 (-54.2%).
The Zacks Revisions Ratio: 2011
Next Fiscal Yr Est – 4 wks
Firms Up
Firms Down
Ests Up
Ests Down
Firms up/down
Industrial Products0.861513666.0015.00
Consumer Discretionary-0.91188138463.002.25
Basic Materials0.3213845162.811.63
Computer and Tech0.843619178772.311.89
Business Service-0.227617151.131.17
Oils and Energy-0.4619181401401.001.06
Consumer Staples-1.20171778850.921.00

Total Income and Share

  • S&P 500 earned $544.3 billion in 2009, expected to earn $777.8 billion in 2010, $886.0 billion in 2011.
  • Finance share of total earnings moves from 5.9% in 2009 to 17.5% in 2010, 18.5% in 2011, regains total earnings crown.
  • Medical share of total earnings far exceeds market cap share (index weight), but earnings share expected to shrink from 17.3% in 2009 to 12.3% in 2011.
  • Market Cap shares of Construction, Retail, Transportation, Industrials and Business Service sectors far exceed both 2010 and 2011 earnings shares.
  • Finance and Autos have rising earnings shares and market cap shares well below 2011 earnings shares.
  • Staples, Utilities and Medical’s share of total net income falling rapidly.
Total Income and Share
Income ($ Bill)Total
$ 2009
$ 2010
$ 2011
% Total
S&P Earn
% Total
S&P Earn
% Total
% Total
S&P Mkt
Computer and Tech$91,865$133,116$150,03316.88%17.11%16.93%18.19%
Oils and Energy$62,514$92,852$105,45711.49%11.94%11.90%11.28%
Consumer Staples$56,876$63,127$69,16310.45%8.12%7.81%8.56%
Consumer Discretionary$23,040$28,072$32,9774.23%3.61%3.72%4.40%
Basic Materials$13,463$22,109$28,1582.47%2.84%3.18%3.35%
Industrial Products$10,790$15,242$19,0251.98%1.96%2.15%2.45%
Business Service$11,494$13,185$15,2072.11%1.70%1.72%2.06%

P/E Ratios

  • Trading at 14.9x 2010, 13.0x 2011 earnings, or earnings yields of 6.71% and 7.69%, respectively.
  • Earnings Yields extremely attractive relative to 10-year T-Note rate of 2.99%.
  • Medical has lowest P/E based on 2010 earnings. Medical, Finance, and Autos cheapest based on 2011 earnings.
  • Construction has highest P/E for 2010 and 2011.
  • Auto and Finance high 2009 P/Es to fall dramatically in 2010 and 2011.
  • S&P 500 earned $57.62 in 2009; $81.98 in 2010 and $93.96 in 2011 expected.
P/E Ratios
Oils and EnergyNM56.513.411.0
Basic Materials14.428.817.513.8
Consumer Staples12.616.516.213.9
Computer and Tech18.417.415.714.3
Consumer Discretionary20.219.717.315.3
Industrial Products18.622.118.115.4
Busines Service20.920.718.015.6
S&P 50021.521.214.913.0

Biggest FY1 Revisions

The table below shows the S&P 500 firms with the biggest increases in their FY1 (mostly 2010) mean estimate over the last 4 weeks. To qualify there must be more than 3 estimates for FY1, and have a mean estimate of more than $0.50. In addition to the change in the mean estimate, the net percentage of estimates being raised is shown for both FY1 and FY2, as well as the P/E ratios based on each year’s earnings is shown.

Note that estimate momentum and value are not mutually exclusive. The most interesting of these firms will be where the net revisions percentage (#up-#dn/Tot) is more than 0.50 but less than 1.00. Big mean estimate changes based on a handful of individual revisions are suspect, but could prove to be the most interesting if other analysts follow suit. On the other hand, if all the analysts have raised their estimates already, the mean estimate is less likely to rise again over the next month.

Biggest FY1 Revisions
Curr Fiscal Yr Est – 4 wks
Next Fiscal Yr Est – 4 wks
# Up-Dn/Tot
Curr Fiscal Yr Est – 4 wks
# Up-Dn/Tot
Next Fiscal Yr Est – 4 wks
P/E using
Curr FY Est
P/E using
Next FY Est
Coventry HlthcrCVH27.94%6.02%1.000.717.179.20
Hartford Fin SvHIG21.17%0.39%0.940.008.376.14
Noble EnergyNBL11.69%6.99%0.790.4420.6418.89
Aetna Inc-NewAET11.18%1.32%0.750.338.449.36
Dell IncDELL9.46%4.38%0.770.619.709.11
Dow ChemicalDOW9.13%2.51%0.930.4016.9912.89
Humana Inc NewHUM9.08%1.29%0.730.148.639.53
Rockwell AutomtROK8.40%7.88%1.000.4516.5614.18
Raytheon CoRTN8.26%-4.49%0.95-0.8210.169.56
Ford Motor CoF8.04%5.76%0.470.257.727.80
Polo Ralph LaurRL7.33%5.75%0.860.7920.6718.25
Ameriprise FinlAMP7.10%3.26%0.920.8311.719.96

We use the convention of referring to the next full fiscal year to be completed as 2010, not all firms are on December fiscal years, this can cause discontinuities in the data, particularly around this time of year.? The data is based on FY1, not based on 2010, even though I may call it 2010 in the report. All numbers, including historical ones, reflect the current composition of the S&P 500, thus some historical numbers may differ from those reported by S&P which are based on the composition of the index at the time of the reports.

Dirk van Dijk, CFA is the Chief Equity Strategist for With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

More about Zacks Strategic Investor >>

This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read our FAQ page at
Five Filters featured site: So, Why is Wikileaks a Good Thing Again?.

View the original article here

No comments:

Post a Comment