What to Watch for in Earnings Season Numbers (Hint: Not Earnings)
Business + Economy

What to Watch for in Earnings Season Numbers (Hint: Not Earnings)

iStockphoto/The Fiscal Times

We’re in the thick of earnings season, with tech giants Apple, Microsoft and Yahoo all set to report their quarterly numbers after the market’s close.

As those earnings numbers and others get released, here’s a pro tip from Jack Ablin, the chief investment officer at BMO Private Bank in Chicago: Don’t just look at the bottom line.

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Expectations for overall corporate earnings last quarter were low — “so low,” Ablin wrote to clients today, “that they are making those pass/fail electives back in college look positively rigorous.” Going into this quarter, analysts expected the S&P 500 would post a 4.5 percent decline in profits, according to FactSet Research. “By most measures those results would suggest a recession,” Ablin says, “although most of the red ink is coming from the energy sector.” Earnings from non-energy companies were expected to rise 2.2 percent from the prior year.

Companies and executives know how to play the earnings season game, though. Every quarter they look to set the bar low and then clear it with ease. Some still miss, but a strong majority of earnings tend to surpass expectations — and that’s held true so far this quarter, too. Through Monday, 72 percent of the 68 companies reporting had topped the Wall Street’s average earnings estimate, just below the five-year average “beat” rate of 73 percent. As a result, the expectation for overall earnings, including those released thus far, has only climbed from -4.5 percent to -3.3 percent. Still not exactly a strong quarter.

But since those earnings numbers can be gamed, Ablin recommends looking to a different line in those earnings reports to get a better sense of how Corporate America is faring.

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“While investors obsess over profits, our concern continues to be a lack of revenue growth,” he says. “Anyone taking entry-level accounting knows that to some extent earnings are in the eye of the beholder; the numbers are about as organic as a box of Twinkies. Revenues plainly cannot be massaged as easily as earnings and the fact remains that Corporate America is struggling to generate incremental sales from one year to the next.”

That hasn’t hurt stocks, but it has left the market trading at 1.9 times sales, Ablin notes — a 26 percent premium to previous norms. “While this valuation metric is still below the brief instance it popped north of 2.0 in 1999-2000, a comparison to stock market valuations at the apex of the craziest mania ever shouldn’t warm too many hearts,” he writes. “The trend is still our friend but the fundamentals have deteriorated.”