This blog post originally appeared on RealMoney Silver on Oct. 21 at 8:45 a.m. EDT.
While it has been widely advertised by chest-thumping bulls in the media that at least two-thirds of the companies that have reported third-quarter earnings have beaten forecasts, there was less than meets the eye to third-quarter profits as in many cases the "beats" were on lowered estimates.
What is often being ignored is how orchestrated earnings season has become, not only that the beats are from lowered and depressed guidance but that, in many cases, there have been high-profile forward-quarter guide downs.
The reality is that companies almost always beat consensus earnings forecasts, even during rough economic periods. Investor relations departments and Wall Street analysts are very good at getting numbers down to the right level before reports are released. As a result, the actual results vis-a-vis expectations or consensus do not vary materially from historical experiences, in good times and even in bad times.
Indeed, the concept of beating is one of the single-most overhyped statistics extant given the degree to which estimates move around prior to reports. Remember that even in the most recent downturn, there were few companies pre-announcing negatively.
What should be more interesting to investors is the composition of the guidance (revenue vs. earnings, higher vs. lower). Also, by category/sector and end market, is the company benefiting from restocking, or is the company closer to consumption and end-market demand?
Let's start by critically digging into this week's earnings reports.
On Tuesday, according to a friend who compiles this stuff, 49 companies reported earnings and provided guidance. As seen in the lists below -- 28 were better, 21 worse -- a surprisingly large 43% of reporting companies either missed estimates or cut guidance or both.
Applied Industrial Technologies
Illinois Tool Works
Bank of New York Mellon
Millicom International Cellular
Nu Skin Enterprises
Crown Castle International
( OXPS) and
Capital City Bank Group
Marshall & Ilsley
The Great Atlantic & Pacific Tea Company
Citizens South Banking
Take these 49 reports and add to Monday's previously reported EPS results, in which 12 releases were better and 19 worse, and exactly half of the 80 companies that have reported third quarter 2009 and are guiding for fourth quarter 2009 have either missed the third quarter or are cutting the fourth quarter. Within this universe, banks and housing were the most conspicuously lousy performers (e.g., Carlisle Companies and Sherwin-Williams in housing on Tuesday). The only banks making numbers are custodians and capital markets participants as credit quality (delinquencies) have begun to reverse.
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 (
) 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
St. Jude Medical
Johnson & Johnson
, State Street,
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:
The third-quarter beats were overhyped as they are the outgrowth from lowered guidance.
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.
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
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At the time of publication, Kass and/or his funds were long Lowe's, Home Depot and State Street, although holdings can change at any time.
Doug Kass is the general partner Seabreeze Partners Long/Short LP and Seabreeze Partners Long/Short Offshore LP. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.