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Wall Street's best-kept secret may be earnings growth

Wednesday, 12 February 2014 - 8:45am IST | Agency: Reuters

Investors can't blame the stock market's bumpy ride so far this year on S&P 500 earnings, which could end the reporting period with the best quarterly growth in more than two years.

Results haven't done much to prop up the overall market, but analysts said that the numbers should relieve worries that last year's big rally came without much gain in profit growth.

Investors turned their focus in recent weeks to volatile emerging markets and less stimulus from the Federal Reserve. At the same time, fourth-quarter earnings growth has clocked in at 9.5% above year-ago results, better than the 7.6% expected when the period began.

Notably, companies that surprised investors with better-than-expected results in terms of both revenue and profits reaped a reward: Their stock prices jumped.

On average, those that beat on both metrics are up 2.1% in the five days that followed their results, according to Bank of America Merrill Lynch research, while those that missed on both are down 5.6% in that time. That gulf is the biggest seen since the fourth quarter of 2008.

Consumer discretionary stocks had the biggest gap between the gainers like Netflix Inc, which rose 20% in the five days following its results, and losers like Amazon.com Inc, which fell 12% in a similar period.

In all, 68% of S&P 500 companies' results are beating analysts' expectations on earnings, above the 63% long-term average, while 66% are exceeding forecasts on revenue, which would be the best "beat rate" since the second quarter of 2011, Thomson Reuters data showed.

"The%age of companies beating on EPS, on sales and on EPS and sales - all of those metrics - are above average. That's a pretty positive sign," said Dan Suzuki, U.S. equity strategist at Bank of America Merrill Lynch in New York.

If the pattern of big swings for consumer discretionary companies' stocks holds, it implies more volatility for those that have not yet reported, including Kohl's Corp, Gap Inc and Lowe's Companies, Inc, as well as other retailers that struggled through the most competitive holiday shopping season for the U.S. industry since the recession.

With results in from about 70% of S&P 500 companies, the group is on track for the best earnings growth since the third quarter of 2011, Thomson Reuters data showed.

Revenue growth at 1.1% is still expected to lag the third quarter, but the%age of companies beating analysts' forecasts is the best in more than two years.

Those are sound results for a stock market that has been turbulent this year, with the Standard & Poor's 500 index posting a 3.6% loss in January and slipping 1.6% so far in 2014.

That downturn follows the S&P 500's 30% gain last year, when earnings rose just 6.1%. Valuations increased sharply because of the price gains, with the S&P 500's forward four-quarter price-to-earnings ratio now at 15.1, compared with 13.1 at the start of 2013, according to Thomson Reuters data.

"A lot of people have begun to wonder about the sustainability of the rally because it was driven so much by multiple expansion rather than earnings, and that's entirely accurate," said Dan Greenhaus, chief strategist at BTIG LLC in New York.

But "earnings are going up - earnings are accelerating," he said.

Many investors were expecting profit growth to pick up in 2014, thanks to a more robust U.S. economy, with double-digit earnings growth projected for the third and fourth quarters.

On some levels, earnings have done well once again by exceeding expectations. Outlooks for the fourth quarter were the most negative of any period since at least 1996, when Thomson Reuters began tracking this data.

The earnings season, to some degree, has been overshadowed by the rout in emerging markets, which prompted a selloff in stocks in the United States and other developed economies.

Financials have had the most positive earnings surprises, with results from insurers like the Travelers Companies, Inc and Allstate Corp among those in that sector that have beaten expectations by the biggest margins.

Not everything is picking up.

Outlooks for the first quarter remain largely negative, with 4.8 companies warning for every one with a positive forecast, Thomson Reuters data showed.

Earnings estimates for all of 2014 have slipped, with growth now predicted at 9.3% versus a Jan. 1 forecast of 10.8%.

(Editing by Jan Paschal)

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