Slower Earnings Growth Ahead?


By Sam Stovall As the week of Jan. 10 week kicks off a new quarterly earnings reporting season, it's worth noting that most investors have become spoiled by the strength in S&P 500 earnings over the past few years, with results consistently coming in better than expected.

What's more, the S&P 500 has posted double-digit, year-over-year increases in operating earnings during each of the past 10 quarters (7 saw advances of more than 20%), with the 2004 fourth quarter projected by S&P analysts to mark number 11, with a gain of 18%.

For the final quarter of 2004, S&P expects all sectors in the S&P Composite 1500 to post year-over-year earnings increases, led by 68% advances for Energy and Materials, upper-20% increases for Health Care and Tech, and a 19% rebound for Telecom Services. Single-digit gains are expected for Consumer Staples, Utilities, and Financials.

SMALL-CAPS LEAD. However, 2005 is a different story. S&P forecasts that earnings growth will slow markedly this year, with the S&P 500 projected to report sub-20% year-over-year increases in each of the four quarters. Of course, it's not like earnings are expected to decline.

As shown in the table below, operating earnings per share are seen rising 10% for the S&P 500, 15% for the S&P MidCap 400, and 20% for the S&P SmallCap 600. And the second half is projected to show a slight improvement over the first.

Which sectors will lead the market? The best performances are expected to be seen from Materials and Technology, while Energy and Telecom Services should post the smallest increases. The five S&P 1500 industries with the best 2005 earnings projections are Commodity Chemicals (+258%), Diversified Metals & Mining (+134%), Oil & Gas Drilling (+81%), Advertising (+77%), and Wireless Telecommunication Services (+75%).

On the downside, the five industries with the worst full-year earnings expectations include Insurance Brokers (-8%), Automobile Manufacturers (-10%), Steel (-12%), Oil & Gas Refining, Marketing & Transportation (-16%), and Forest Products (-39%).

OPERATING EPS % CHANGES, YEAR-OVER-YEAR

S&P 1500 Sector

2004 Q1A

2004 Q2A

2004 Q3A

2004 Q4E

Year

2005 Q1E

2005 Q2E

2005 Q3E

2005 Q4E

Year

Consumer Discretionary

54

32

24

10

27

6

9

12

18

11

Consumer Staples

3

13

12

3

8

5

3

3

11

5

Energy

4

68

57

68

46

22

2

(6)

(9)

1

Financials

35

16

2

6

14

(1)

3

16

14

8

Health Care

10

38

14

27

22

11

9

10

13

11

Industrials

45

15

18

16

22

14

30

16

11

18

Information Technology

84

128

44

28

59

23

22

24

19

22

Materials

119

90

109

68

94

33

17

15

35

24

Telecommunication Services

(15)

(9)

5

19

(1)

12

5

(4)

3

3

Utilities

(5)

30

(15)

4

(1)

18

4

23

8

14

S&P Composite 1500

28

32

17

18

23

10

9

12

12

11

S&P 500

27

31

17

18

23

9

9

11

11

10

S&P 400

37

36

13

16

24

14

11

17

18

15

S&P 600

35

38

35

39

37

20

17

22

21

20

BEATING THE BUBBLE ERA. During 2005, the S&P 500 is projected to post full-year per-share earnings under generally accepted accounting principles (GAAP) in excess of $60 and operating earnings above $70 -- both of which are records, even including the bubble years of not-so-long ago.

And yet, in our view, equity valuations are not out of line. In fact, the S&P 500's GAAP p-e of 20.7 is a shade below its average of 21.5, dating back to 1984. But we note that the S&P 500 would have to decline 25% in order for its current p-e to equal the average p-e of 15.5 since 1935.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the industries in the S&P 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), their proxies (the highest STARS-ranked companies in the subindustry index -- tie goes to the largest market value) as of Jan. 7, 2005.

Industry

Company

Ticker

STARS

Recent Price

Agricultural Products

Archer-Daniels-Midland

ADM

3

$22

Commodity Chemicals

Lyondell Chemical

LYO

3

$28

Consumer Electronics

Harman International

HAR

3

$117

Fertilizers & Agricultural Chemicals

Scotts Co.

SMG

4

$69

Hotels, Resorts & Cruise Lines

Carnival

CCL

4

$58

Internet Retail

eBay

EBAY

3

$107

Internet Software & Services

Yahoo!

YHOO

4

$36

Managed Health Care

PacifiCare

PHS

5

$56

Multi-Sector Holdings

Leucadia Natl.

LUK

NR

$43

Oil & Gas Refg., Mktg. & Trans.

Valero Energy

VLO

4

$43

Steel

Nucor

NUE

3

$49

Wireless Telecom Svcs.

Nextel Partners

NXTP

4

$20

Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.

Disclaimers

This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Stovall is chief investment strategist for Standard & Poor's


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