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Earnings: Nowhere to Go but Up

With a week left in the second quarter of 2009, investors are clinging to hopes that U.S. companies can finally stop the slide in their profits. For months, stocks have risen as economic prospects improved somewhat and corporate earnings bounced back from a disastrous 2008 fourth quarter. Results that were "not as bad" were enough to impress investors, says Standard & Poor's senior index analyst Howard Silverblatt. (Silverblatt is a contributor to BusinessWeek's Investing Insights blog.) "But at some point, we're going to have to prove we're getting better." Expectations are low for second-quarter results. According to Standard & Poor's, analysts expect operating earnings this quarter for the broad S&P 500 index to drop 15.9% from the year before. But, if analysts are right, those earnings will still be 41.4% higher than the first quarter, which was in turn a big improvement over the loss posted in the 2008 fourth quarter. Oracle Impresses the Street Further improvement is expected the rest of the year: S&P says analysts expect operating earnings to rise 5.5% from the second to third quarter, and 7.95% from the third to fourth. The problem is that this only looks like good news from the perspective of late 2008, when the economy was in free fall. Compared with 2006 or 2007, results are still very weak. "We're bouncing along the bottom here," says Jon Christensen of . The economic recovery will be slower and more painful than usual, so it could take a while before profits rebound in a significant way. "I don't think we're going to be zooming out of this recession any time soon," he says. Nonetheless, many companies are stopping the slide in their earnings—and even beating Wall Street's low expectations—with steep cost-cutting. One example is ( (ORCL)), which on June 24 rocketed 7% higher after a quarterly report showed earnings of 46¢ per share, 2¢ better than Wall Street expectations and only 1¢ below last year's result. The software outfit managed to achieve these profits despite a 5.5% drop in revenue. Growth May Have to Wait When the financial crisis heated up last fall, companies did everything they could to maintain profit margins: They reduced payrolls, trimmed inventories, and found other ways to cut costs. "Given how quickly things really started unraveling last year, companies have done quite a good job," says Chris Trompeter, portfolio manager at . "But it's a double-edged sword because they've laid off a lot of people and cut back on spending, which has negative consequences for the economy." Thomson Reuters ( (TRI)) global head of research Ashwani Kaul says it could be until 2010 that U.S. companies start to see revenue growth, rather than merely profit growth. Much of the optimism about 2009 earnings is driven merely by cost-cutting and by favorable year-over-year comparisons, he noted. "You can only cut so much," Christensen says. He predicts earnings growth will be constrained until companies actually start to see their sales increase again. Earnings from the second quarter of 2009, which for most companies ends on June 30, will, oddly enough, be helped by the bankruptcy of last month. Huge losses at GM this quarter were expected to take a big bite out of S&P 500 earnings, Silverblatt says. Since its bankruptcy, however, the automaker has been removed from the S&P 500 index, which in the process added more than 4% to overall earnings predictions. Artificial Boost to Earnings This artificial boost to earnings—just like the more authentic boost from cost-cutting and layoffs—are not signs of an improving economy. In fact, they're the opposite. So, while second-quarter results may again demonstrate that profits have stabilized, there may not be much cheer on Wall Street. It could be quite a while before investors have something to celebrate on the earnings front.
Steverman is a reporter for Bloomberg News in New York.

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