Editor's Note: This is a bonus column from Chuck Hill, whose commentary usually appears only on

RealMoney

. We're offering it today to

TheStreet.com

readers. This column originally appeared on

RealMoney

on April 6 at 12:00 p.m. EDT. To read Hill's commentary, please click here for information about a free trial to

RealMoney.

Alcoa's

(AA) - Get Report

quarterly report after today's close will once again mark the unofficial start of the reporting season. However, the season gets off to a staggered start this year, as there's not much else in earnings coming for the rest of this week.

However, many retail companies will be reporting their same-store sales for March on Thursday. Those March retail sales results normally would provide some insights into consumer spending at the end of the quarter. But with Easter falling in March this year, the results will not have as much meaning as usual.

Retail Metrics is expecting year-over-year same-store sales growth of 4.6%, but even with the inclusion of Easter in this year's March numbers, the 4.6% is slightly less than the 4.8% gain in February. This year's March also comes up against a tough comparison, as the 6.7% gain in March 2004 was the year's highest monthly gain. So unless there is a big surprise in either direction, investors looking to gauge some direction on first-quarter earnings in the consumer discretionary sector likely will find the same-store sales reports to be inconclusive.

The pace of earnings reports will pick up somewhat next week, but the mix of companies reporting next week is heavy on banks, with a smattering of tech companies. The floodgates do not open until the following week, and the major energy companies, who will have a big say in this quarter's results overall and relative to expectations, do not report until late in the reporting season, so unfortunately it will likely be well into the week of April 18 before the first-quarter earnings picture starts to come into focus. In the meantime, a few bellwethers in sectors outside finance may provide some meaningful clues on where the overall results might be headed.

Manage Your Earnings Expectations

We've become accustomed to seeing very good earnings reporting seasons of late. Over the last six quarters, investors have watched the

S&P 500

companies report very strong earnings growth: Starting with the third quarter of 2003, the sequence for year-over-year earnings growth has been 21.3%, 28.3%, 27.5%, 25.3%, 16.8% and 19.7%. Obviously, the last two quarters in that sequence faced tough comparisons to the year-ago quarters.

To put that in perspective, the long-term earnings growth for the group has been about 7% per year on average. That holds whether you look back 30 years or 100 years, new paradigms notwithstanding. But the growth in each of the last six quarters has been over twice that 7% average.

Those rates of growth were not unusual at that stage in a business cycle recovery, but as in past cycles, rates of that magnitude are clearly unsustainable. It should be no surprise that earnings growth is slowing sharply. The kind of slowing expected for this quarter will likely be in line with the deceleration seen in past cycles. Thomson First Call reports that industry analysts are looking for growth of 8.2%. It will surely be higher than that, since the actual earnings results always beat the final estimates.

Over the past 12 years, the aggregate results for the S&P 500 companies have beaten the aggregate final earnings estimates by an average of 3.1%. Through 2003 and into the first quarter of 2004, the actual earnings reported beat the final estimates by over 5.0%. That slipped as low as 2.6% in the third quarter, but bounced back in the fourth quarter to 4.1%. The question is whether the third quarter or the fourth quarter was the anomaly in what is likely a downward trend. It does seem likely that 5% is not in the cards for this quarter. More likely is a surprise factor between 2% and 4%, which would put the actual year-over-year earnings growth at about 11%.

In most quarters, analysts (in the aggregate) trim the estimates for their companies during the quarter. This quarter, the estimates actually rose some, and after first falling a fairly typical percentage point or so in January, the expectation rose a very atypical 2 percentage points the next two months. That may bode well for beating the estimates by a better-than-average amount, pushing the surprise factor toward 4% or so.

Even though year-over-year earnings growth of 11% would be a lot less than last quarter's 19.7% year-over-year earnings growth, investors should not be concerned with the lower growth rate. Whether it is 11%, or a percentage point or so above or below the 11%, investors should be satisfied because results in that range would be in line with the normal pattern in an earnings recovery cycle. And it would still be well above the long-term 7% average.

An Alternative View

Another way investors can look at the results relative to expectations is by measuring the number of companies that beat, matched or fell short of the final estimates in each quarter. On average over the last 12 years, 59% of the S&P 500 companies have beaten the quarterly estimates, 21% have matched and 20% have fallen short. The distribution always has a positive bias, and this is what creates statements every quarter to the effect that everything is great because earnings are beating expectations.

Over the last two years, the distribution has run more positive than normal in every quarter. The number beating the final estimates over the last two years was above 61%, hitting 73% in the first quarter of 2004. The number matching expectations was about normal in 2003, averaging 20%, but fell to the midteens in 2004. Meanwhile, the number falling short was either slightly above or slightly below 15% throughout 2003 and the first half of 2004. But the number falling short bounced back to about normal in the two most recent quarters.

The distribution was most positive in the first two quarters of last year, and seems to be trending back to normal. But even if the distribution is no worse than average in this reporting season, that means we're in for a lot of good news over the next few weeks. Most of the earnings reports should be better than expectations, but then, they always are.

However, when the pundits say everything is great because earnings are beating the estimates, remember, earnings always do better than expectations. The germane question should be whether earnings are beating the estimates by an amount that is more or less than usual and/or whether the distribution of the companies beating, matching or falling short of estimates is more or less positive than normal. Savvy investors will apply a close filter to the rosily depicted results to see if they are really as rosy as they seem.

Charles L. Hill, CFA, is the CEO and Eminence Grise of Veritas et Lux, a firm providing investment research, particularly on corporate earnings, the economy and market strategy. Previously, he served as director of research at Thomson First Call. At the time of publication, Hill had no position in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, Hill invites you to send comments on his column to

charles.hill@thestreet.com.