|Value at Risk |
The 30 highest price/earnings ratios in the S&P 500
|RHI||Robert Half Intl.||28.29||70.72|
|AMCC||Applied Micro Circuits||4.29||61.29|
|FCX||Freeport McMoRan Copper&Go||34.74||43.42|
|MXIM||Maxim Integrated Products||48.22||40.18|
|*Based on 2004 calendar estimates. |
Source: Standard & Poor's
Wouldn't it be nice to know which companies are most likely to bomb in the upcoming earnings season, and which might thrive? Such an insight could be particularly valuable this quarter, given
the drubbings with which even the smallest disappointments are being met. No matter how well companies try to prepare investors for their quarterly financial results, there are always some firms that manage to disappoint and others that report much better-than-expected numbers. In the fourth quarter of 2003, nearly one in three companies missed or beat analysts' estimates by at least 10%, according to a recent study by Parson Consulting. Figuring out who is going to miss, in particular, could save investors a lot of money in the current market, which some think is in the process of selling down the premium built in to stocks during 2003. That run-up created a dynamic in which many stocks are "so expensive that a potential upside surprise is probably anticipated fully by the stock price, while any downside disappointment would make those stocks vulnerable" to a decline, said Gary Tapp, chief quantitative strategist at SunTrust Robinson Humphrey. While handicapping earnings to the penny is never easy, some companies do have a history of missing analysts' forecasts while others have a reputation for beating the estimates soundly. Of course, there's no guarantee that history will repeat in the second quarter, and companies that do meet or beat the projections could warn of weaker-than-expected results going forward, as Yahoo! ( YHOO) did. Still, a company's track record can give investors an idea about who might be vulnerable and who may be poised to gain. According to data from Thomson First Call, 25 S&P 500 companies have missed analysts' earnings estimates in at least three of the last four quarters. El Paso ( EP), Symbol Technologies ( SBL), HCA ( HCA) and Allied Waste ( AW) have actually disappointed investors for four straight quarters. Conversely, about 150 companies have surpassed analysts' forecasts for four straight quarters, with firms like General Motors ( GM), Centex ( CTX), EOG Resources ( EOG), Autodesk ( ADSK) and Deere & Co. ( DE) beating the estimates by a wide margin.
SunTrust's Tapp screens for companies that are likely to miss or exceed consensus estimates and then looks to see which of those firms are expensive or cheap. His "earnings surprise" model takes into account 17 factors, including recent trends at the company and analysts' estimate revisions. His "pure value" model includes a number of valuation metrics like price-to-earnings and price-to-cash flow. Based on his analysis, Tapp thinks Schering-Plough ( SGP) and Waste Management ( WMI) are in a precarious position right now. While many analysts have high hopes for Schering-Plough's new cholesterol drug Vytorin and believe a successful launch could spark a rally in the stock, Chief Executive Fred Hassan has warned that 2004 would be a year of "difficult financial comparisons." The company is still trying to recover from the loss of almost 90% of its revenue from its allergy drug Claritin, which lost patent protection in late 2002. Schering-Plough, which has missed analysts' earnings estimates in three out of the last four quarters, has a negative trailing and forward P/E and holds a price-to-sales ratio of more than 3. Although Waste Management is less expensive, Tapp still considers it pricey at 23 times trailing earnings and 1.5 times sales. The company has also missed analysts' estimates in three out of the last four quarters. Among other companies that Tapp considers vulnerable are Newell Rubbermaid ( NWL), Eli Lilly ( LLY) and Equity Residential ( EQR). Eli Lilly hasn't reported weaker-than-expected earnings in recent quarters but has said that it is evaluating its manufacturing and development strategies, which could lead to asset impairments and potential charges in the second quarter.
Real estate investment trust Equity Residential has said it is "cautious in
its expectations for the remainder of the year," and some analysts have recently lowered their estimates on Newell Rubbermaid. Tapp, whose firm has a banking relationship with Equity Residential and Waste Management, said EQR, Eli Lilly and Newell are all trading at lofty valuations. Other stocks, like Starbucks ( SBUX), C.R. Bard ( BCR) and St. Jude ( STJ), aren't at risk of missing consensus estimates in the second quarter but are trading at levels that make Tapp nervous going into the earnings season. "We don't think anything is going to happen but certainly if anything does happen, there's vulnerability there," he said. "Earnings are very strong but our advice is to ... take partial profits." Many of the upside earnings surprises this quarter should come from the industrials sector, followed by technology, consumer discretionary and energy, according to Tapp. But with expectations for strong earnings already priced into many stocks, it's important to be selective. Tapp recommends ConocoPhillips ( COP), Louisiana Pacific ( LPX) and Chubb ( CB), which he said have a good chance of surpassing analysts' earnings estimates in the second quarter and are attractively valued.