Learnings from earnings
Equity analysts are sharpening their red pencils. As euro zone worries clog the wheels of global commerce, forecasts for corporate earnings are falling. Yet global investors may still be expecting too much from companies, at least in the near term.
Estimates for the S&P 500 index of U.S. companies have been steadily hacked back in recent months. Last July, analysts expected earnings in the current quarter to grow 18 percent, according to Thomson Reuters’ “This Week in Earnings” report. Now they think the constituents of the S&P 500 will improve their combined earnings by only 6.5 percent in the three months to the end of June. Take out financials – the absence of last year’s Bank of America lawsuit settlement will flatter growth in 2012 – and the prognosis is for earnings to shrink year-on-year. Take out Apple, whose size and strength boosted aggregate earnings growth in the first quarter from 5.7 to 8.1 percent and the picture gets bleaker still.
Over in Europe the bad news is worse. Earnings of euro zone companies shrank by 6 percent across the whole of 2011, Thomson Reuters data shows. And while the latest estimates suggest there could be growth in 2012, it is sobering to recall that, this time last year the 2011 consensus was that euro zone corporate earnings would rise 9 percent.
Monetary stimuli of the sort signalled by the U.S. Federal Reserve on June 20 may help to prop up the economy, and markets. Low equity valuations, especially in Europe, also offer some protection. The forward price-earnings multiple for U.S. shares is 12, compared to a 25-year average of 15. European stocks trade on a multiple of just 8 times expected earnings for this year. Some disappointment is already priced in.
Nevertheless, profit warnings this week from Procter & Gamble and Danone suggests forecasts may still be too high. And history suggests that when corporate earnings go into reverse, the shift is rarely gradual. Since 1971, the combined earnings of S&P 500 companies have expanded by an average of about 8 percent a year. In periods that failed to meet that norm, however, earnings typically shrank by 6 percent on average. This could be one of those years.