Kass: The Earnings Season Racket

When all is said and done, it will be interesting to see what revenue and EPS revisions do for the fourth quarter and 2010, and how they are different by sub-sector and category (demand vs. restock).

Clearly, for now, the market has been and is going up, but in my view, we are also at the point where something else (read: liquidity) besides the much ballyhooed earnings reports this third quarter is doing it. Frankly, earnings season has been very mixed regarding composition and forward outlook and has also included some high-profile disappointments. Some examples of high-profile companies that have either missed third-quarter estimates or have lowered fourth-quarter guidance include Acer, St. Jude Medical (STJ), General Electric (GE), Johnson & Johnson (JNJ), Grainger (GWW), Fastenal (FAST), Home Depot (HD), Lowe's (LOW), Pulte Homes (PHM), Domino's Pizza (DPZ), Yum! Brands (YUM), State Street, CSX (CSX), Honeywell (HON) and Weyerhaeuser (WY).

Our final analysis is taken from data recently delivered by Goldman Sachs' David Kostin. What is most revealing is the manner in which he divides categories into (especially regarding end demand) consumption vs. intermediaries.

As I have been writing, my conclusion is that if we back out semiconductors and the inventory restocking side of the equation, the profit picture on the consumption side of the economy remains less healthy than is generally recognized.

In support of this, it is Kostin's view that top-line results also suggest some preliminary cause for concern:

• Only 33% of companies beat consensus sales estimates by greater than one standard deviation vs. 40% in the last 20 quarters.
• The good news is that 10 out of 14 intermediary companies (distributors, etc.) beat sales by more than one standard deviation, showing inventory restocks continuing (stronger than expected), and stocks went up 5%.
• The bad news is that only six out of 33 end-demand companies (true picture on end demand) beat sales estimates by more than one standard deviation.
• Out of the seven companies that missed sales estimates by more than one standard deviation, 100% were end-demand companies.

There are several conclusions one could draw from today's column:

1. The third-quarter beats were overhyped as they are the outgrowth from lowered guidance.
2. If one divides the third-quarter earnings reports by end-market categories, differentiating between the beneficiaries of restocking and those companies that are closer to the end markets and consumption, it leads to two different pictures as to the health of corporate earnings.
3. If end demand doesn't pick up (and pick up quickly), the 2010 earnings outlook for many industries (such as semiconductors and other beneficiaries of restocking) will be in jeopardy, as will be the now ambitious consensus for S&P 500 earnings of over $70 a share next year.

Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.

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