A Sector-Level Look at Earnings


By Sam Stovall Even though companies began announcing third-quarter results in the first week of October, earnings reports begin in earnest this week. Such industry leaders as Coca-Cola (KO), General Motors (GM), and IBM (IBM) were scheduled to post results, along with many banks, on "Super Tuesday," Oct. 14.

Individually, most investors can find out from a variety of sources what individual companies are likely to report. But rarely do they get the opportunity to view the earnings landscape from a higher, sector level.

Take a look at the table below, which aggregates S&P analysts' individual company estimates (on a market-cap-weighted basis) into a sector-level "bottom-up" view of how we see earnings growth for the period just ended, as well as for the fourth quarter, the full year 2003, and all of 2004.

S&P Analysts' Estimates of Year-Over-Year % Changes in Operating Earnings

Sector/Index

Q1A

Q2A

Q3E

Q4E

2003E

2004E

Consumer Discretionary

9

3

7

15

9

13

Consumer Staples

2

-5

-10

3

-3

4

Energy

142

46

44

22

59

-17

Financials

1

27

31

34

22

12

Health Care

13

-8

13

15

8

22

Industrials

-14

-7

8

24

2

20

Info. Tech.

214

121

275

76

142

50

Materials

2

1

-3

41

8

63

Telecom. Svcs.

37

45

-21

-25

1

1

Utilities

-21

-35

-3

10

-14

10

S&P 1500

15

11

19

21

17

14

S&P 500

15

11

19

21

16

13

S&P 400

11

15

28

26

21

22

S&P 600

13

8

23

21

16

25

A- actual. E- estimated.

Operating earnings increases for the S&P 500 are projected to accelerate during the second half of 2003, posting a full-year increase of 16%. Earnings are then likely to advance by 13% in 2004. And as the U.S. economy continues its expected recovery -- David Wyss, S&P's chief economist, is forecasting a 3.7% increase in real gross domestic product this year and a 4.7% jump next year -- the small and midcap components of the S&P SuperComposite 1500 (the combined S&P 500, S&P MidCap 400,and S&P SmallCap 600 indexes) are projected to post earnings increases in excess of that expected for the large-cap S&P 500.

For the quarter ended Sept. 30, it appears that the greatest percentage increase will likely come from the technology sector, with the five greatest above-market gains expected to come from the application software, computer hardware, computer storage and peripherals, semiconductors, and system software sub-industries.

TELECOM LAGGARDS. Energy issues are also expected to post strong year-over-year increases, with only the drillers subgroup projected to show an earnings decline. Finally, financials are likely to have the third-best showing of the 10 sectors in the S&P 1500, led by above-market increases in the three insurance categories: Life, multiline, and property and casualty.

The sectors that are expected to post the worst results are telecommunications services (the integrated telecom-services companies are projected to post a 22% decline, while the much smaller wireless companies should see a 13% advance), consumer staples (led by a double-digit decline for distillers and vintners, and modest declines for food retail and tobacco stocks), and utilities (dragged down by a projected 12% decline for electric utilities).

S&P analysts see a favorable trend in the improved quality of earnings. In 2002, as shown in the graph below, the price-earnings ratio for the S&P 500 ranged from a low of 19, based on operating results, to a high of 37, based on the more conservative Standard & Poor's Core Earnings, which excludes a pension plan's impact on earnings yet includes stock-option expenses. Today, the gap between those measures has narrowed: The p-e ratios are separated by only two percentage points, based on 2004 estimates.

In summary, S&P sees corporate earnings continuing to advance, along with the economy, which should allow the overall market to work its way higher over the coming quarters. S&P's Investment Policy Committee's targets for the S&P 500-stock index remain at 1,085 and 1,190 for 2003 and 2004, respectively, driven by a recovering economy, rebounding corporate earnings, and valuations that are expected to stay within normal ranges.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of October 10, 2003.

Industry/Sector

Company

S&P STARS* Rank

Computer & Electronics Retail/Consumer Discretionary

Best Buy (BBY)

5 STARS

Computer Storage & Peripherals/Info. Tech.

Storage Technology (STK)

4 STARS

Consumer Electronics/Consumer Discretionary

Harman International (HAR)

Not Ranked

Diversified Metals & Mining/Materials

Phelps Dodge (PD)

3 STARS

Homebuilding/Consumer Discretionary

D.R. Horton (DHI)

5 STARS

Internet Retail/Info. Tech.

eBay (EBAY)

3 STARS

Internet Software & Services/Info. Tech.

Yahoo! (YHOO)

3 STARS

Office Electronics/Info. Tech.

Xerox (XRX)

2 STARS

Semiconductor Equipment/Info. Tech.

ATMI (ATMI)

5 STARS

Semiconductors/Info. Tech.

Intel (INTC)

5 STARS

Wireless Telecom Svcs./Telecom Svcs.

Nextel (NXTL)

5 STARS

* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief investment strategist for Standard & Poor's


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