Posted by: Howard Silverblatt on May 19, 2011
For 18 consecutive quarters, from Q2,’02 through Q3,’06, S&P 500 operating earnings increased at least 10% each quarter. Initially the gains were a rebound from the earnings declines of the 2000-2002 Bear market and recession, and later on they were reflective of an accelerating market and recovering economy. Then came the housing bust, liquidity, unemployment, and for a brief period, true fear. However, with Q1,’11 earnings mostly behind us (97% reported), the S&P 500 has now posted five consecutive quarters of double-digit earnings gains. Based on current estimates through Q4,’12, the index is expected to post another seven consecutive quarters of double-digit gains, bringing the run to at least 12. In addition, Q3,’11 is expected to post an all-time high for earnings, at US$ 25.09 per S&P 500 share (or US$ 228.7 billion in aggregate), outpacing the current record of US$ 24.06 (US$ 213.7 billion in aggregate) set in Q2,’07. Therefore, at least according to the estimates, another five consecutive quarters of earnings records after Q3,’11 can be expected; nice if it happens. Now before you target your party-pooping Bear gun at me, just because I question that all quarters may not be record-setting quarters does not make me a Bear. Earnings, in my opinion, are doing quite fine. Q1,’11 posted near-record earnings (and if I ‘play’ with the Financials they did make a record), cash flow has set an all-time record (and the last time I checked, mark-to-anything doesn’t change cash flow); cash itself appears ready to set another record level for Q1,’11, and in my S&P Indices 2010 Annual Pension and OPEB report, I’m characterizing the US$ 455 billion in underfunding as “an acceptable and manageable expense, well within income and assets levels.” In addition, companies have accomplished all this in a high unemployment environment, with consumers displaying a bit less than their typical spend-thrift ways. However, double-digit record-setting earnings for (at least) another record six consecutive quarters in this environment, maybe, but. One but that I’ve come to watch and use in my analysis is the top-down estimates, compared to the bottom-up which is used much more than top-down. While bottom-up quantifies all the issues and permits issue comparisons, analysts do have a history of being a bit optimistic - the sun, as well as earnings and stock prices, will come out (and up), tomorrow, or at the very least the statement after that. However, top-down estimates, typically from economists and strategists (many of whom are economists by training), have a history of seeing problems in the economy (which impact earnings and prices) before individual analysts see it. To be fair (and unbiased, of course), top-down estimates are also typically slow to reflect the resolution of a problem. Given that top-down estimates now indicate that things may be a bit more volatile and less optimistic than bottom-up estimates predict, a second look at the market seems advisable, especially when so many agree that earnings will only go up (not everyone loves a crowd).
Currently, 2011 full year estimates for both bottom-up ($98.06) and top-down ($94.89) estimates predict that 2011 will be a record year (not sure if that’s a buy or sell signal), beating the record set in 2006 ($87.72), with both also expecting Q3,’11 to set a quarterly record (bottom-up $25.09, top-down $24.07, with the current record of $24.06 being set in Q2,’07). However, top-down is pointing to a much slower growth rate after that, with next year’s earnings growth rate estimated at 6.7%, compared to the bottom-up estimate of 14.0%. Both annual estimates set new records for 2011 ($111.79 for bottom-up and $101.21 for top-down) and show growth, but bottom-up is over 10% higher. The concern I have is that we appear to be focusing on bottom-up only, dismissing the group that has a decent (but nowhere near perfect) record of sending up an early warning signal. The fact that top-down estimates show growth is a positive sign, but the reduced rate of growth suggests that we should reexamine what we are paying for forward growth, least we get ahead of ourselves. If you are a committed long-term holder who will hold the stock regardless, then the difference is a blip on the scope. But for the rest the investing public (a not so silent majority), accepting any forward estimate, which mostly everyone says is going straight up, deserves a watchful eye, and maybe even some set limit orders.
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