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|  | DECEMBER 29, 2005
By Alex Halperin Ending the Year with a BangS&P forecasts robust corporate earnings for the last quarter of 2005. But don't bet on the trend continuing indefinitelyThe last months of 2005 may be considered a shaky period for the markets, but analysts see rock-solid corporate earnings. Standard & Poor's projects that companies listed in its flagship S&P 500-stock index will set a quarterly operating earnings record of $20.62 per share for the fourth quarter, up 14.9% year-over-year. This would mark the 15th consecutive quarter of double-digit year-over-year EPS growth for the 500 companies. "The expected earnings slow-down hasn't materialized, due in large part to the continued strength of consumer spending," says Howard Silverblatt, equity market analyst at S&P. "For 2006, Standard & Poor's expects the positive momentum to continue but at a slower rate, with a wide variance in sectors." According to S&P, the energy sector has led the way in earnings growth, thanks to strong crude oil and other energy prices. Meanwhile, financials, materials, and utilities are among the groups that have lagged. RECORD-SETTERS. Along with strong consumer spending, companies also received notable boosts from corporate share buybacks, which hit a new high of $315 billion this year, S&P says. Reducing the number of shares on the market is a quick way to boost per share earnings. Silverblatt estimates that without the buyback growth, earnings per share growth would have been a still impressive 13.4%. "It's a legitimate use of cash -- it's not a trick," Silverblatt says. But the buybacks raise the question of how companies will increase EPS next year. The record earnings can't all be attributed to accounting maneuvers. On an aggregate basis, S&P sees index companies' earnings at $699 billion, up from $630 billion in 2004. Other records hit by the companies this year include dividend payments of $202 billion and cash holdings by the old S&P industrials at $635 billion. S&P is also estimating that new records will be set in 2006 for earnings and dividends, with both expected to post gains of over 10%. The fact that index companies have sustained double-digit earnings growth for so long is "obviously a surprise," Silverblatt says. At least in the short term, he describes the share buyback move as a "win-win." Investors' portfolios rise when companies beat earnings expectations, while companies get a use for their excess cash. And the newly-acquired shares can be redeployed to raise money for future expenditures, though this could dilute earnings. HURRICANE LIFT. Even so, buybacks aren't how investors want to see companies clock up all of their earnings. "It won't take long for analysts on the Street to figure out" what's going on, Silverblatt says, and they'll soon want to learn exactly how much their investment is worth. One point S&P's predictions drive home is that Hurricane Katrina appears not to have hit corporate earnings as badly as some feared. In fact, the energy sector actually benefited from the disaster. S&P hiked its predictions for the sector's annual earnings, from 35.62% to 44.55%, in the storm's wake. "Prior to the hurricane we expected earnings to go down," Silverblatt says. Once the storm hit, it became clear that energy companies could pass price increases directly to consumers. "All of a sudden, anything they had in the pipeline went up to a higher price," he says. ENERGY LEAK? On the other hand, materials companies didn't fare as well. For example, companies producing petroleum-based plastics can't alter preexisting contracts in the wake of natural disasters. As a result, the sector took a big hit, and S&P projects a drop of 8.4% for earnings in the fourth quarter of 2005 year-over-year. S&P thinks the industry will continue to weigh on earnings growth for the index in the coming year. Thomson Financial, which calculates total earnings, as opposed to per share figures, projects 13.3% year-over-year earnings growth for the fourth quarter, close to Silverblatt's estimate. Looking at 2006, Thomson research analyst John Butters sees continuing strong earnings growth -- down a few clicks to 13.1% -- powered by consumer-discretionary spending and information technology. Both Thomson and S&P forecast health care and consumer staples will be soft in the new year. Thomson sees the energy sector's earnings growth dropping 35 percentage points to 13% in 2006, but this figure is a little deceiving. It still projects double-digit growth coming on top of the sector's astounding profits in 2005, which were driven by spikes in energy prices after Katrina and instability in oil-producing regions. Unforeseen events could send the price of oil back to towering heights. EYE ON THE TRIAD. Like Silverblatt, Butters says that from a corporate earnings perspective, Katrina didn't live up to fears. There was some drop in financials, especially reinsurance companies, but as a whole "we didn't really see that much impact." Of course, no one can predict the next Katrina or similarly traumatizing events, but Silverblatt says investors have plenty to watch in early 2006, especially following the buybacks. He suggests keeping an eye on the linked triad of interest rates, political stability, and oil prices. Unlike the push for Social Security privatization in 2005, Silverblatt doesn't expect any blockbuster legislation to have much influence. However, early in its session, Congress may send up "test balloons" on bills of interest to the business community, like pension reform and reducing high-risk mortgages. MIDYEAR SNAP? In the meantime, both Silverblatt and Butters project strong earnings to continue for the consumer-discretionary and information-technology sectors, with lower earnings growth estimated for health care and consumer staples. As a whole, will the index maintain its streak of double-digit earnings growth? S&P predicts it will snap in the second quarter of 2006. Silverblatt figures that after this year's remarkable performance, investors should expect 2006 to be more mixed. That means investors should tread more carefully.  Halperin is a reporter for BusinessWeek Online in New York
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