(James Saft is a Reuters columnist. The opinions expressed are
his own)
By James Saft
Oct 25 (Reuters) – Corporate earnings and revenues can’t, as
they are doing this earnings season, diverge forever.
Just about halfway through the U.S. third-quarter corporate
reporting season and we find that 59 percent of S&P; 500
companies have beaten their earnings estimates, down a bit from
last quarter but still an upbeat number.
And yet about 60 percent have missed their sales targets,
meaning that corporate America is somehow extracting more profit
than promised despite bringing less money into the tills than
expected.
That’s admirable, but perhaps a bit disturbingly close to
magical.
On many readings, all is rosy in the land of equities. Not
only does the market have crucial support from central banks
bent on forcing money into risk assets (and hoping some of the
profits get spent), earnings are at record highs and the amount
investors will pay for a share of those earnings is going up.
Analysts are forecasting fourth-quarter earnings to grow at
a near 9 percent clip, down from the 17 percent they were
penciling in earlier but still enough to take the earnings of
the S&P; 500 to almost $27 per share, in what would be yet
another record.
And next year analysts are looking for growth of about 12
percent. That optimism, combined with quantitative easing fever
and complacency over the euro zone, has
allowed price-to-earnings multiples to expand, and not just in
the United States.
On a global basis, forward-looking P/E valuations have
gotten richer since early June, according to Morgan Stanley
analysis, most notably for companies in mining, materials,
energy and even finance.
That’s all well and good, but very hard to square with the
increasing number of companies saying they haven’t been able to
deliver promised growth in revenues. The huge majority of S&P;
500 companies giving revenue or earnings guidance for the coming
quarter have guided downwards, according to data from FactSet.
Third-quarter revenue for chemicals company DuPont
dropped 9.2 percent from the year-before quarter, to $7.4
billion, below the $8.15 billion analysts expected, a miss the
company blamed on global drops in demand. DuPont slashed its
full-year earnings estimate to between $3.25 and $3.50 a share
from about $4.20 before.
Similarly, farm and construction equipment maker Caterpillar
Inc lowered its forecasts for the second time in a year,
citing economic weakness and uncertainty.
WHERE’S THE GROWTH?
So, we have a trend towards lower revenue growth, a
dwindling number of companies beating expectations and yet a
world in which investors see this combination as growing in
value.
In some ways this is reminiscent of the housing market in
the middle years of the last decade, where prices, year after
year, outpaced wage and income gains. The argument then was that
incomes would soon catch up and that housing was cheap on a
financing basis.
Housing, of course, was brought down with a thump when
people finally worked out that the two numbers – cost and the
amount of money available to service the debt backing that cost
– could not forever drift further apart.
So it may prove for shares.
Surely some of the growth of earnings is a credit to company
managers, who are proving unrelenting in wringing efficiencies
from corporate structures, allowing for earnings growth even
in challenging times.
Earnings are, on some level, an opinion. There is art to it
as well as just math. Think about a bank which values assets and
that drives earnings: those marks are ultimately subjective.
While earnings may be more or less than meets the eye, a dollar
in revenues is always a dollar.
Try this: compare earnings on an economy-wide basis and
compare to overall economic output. On this measure, corporate
America does not have a lot of room to expand its share of the
pie, because earnings as a percentage of GDP are at near-record
highs and are about half as high again as the kinds of figures
we saw in most of the past 50 years.
The upside is, if the growth of earnings is confirmed over
time by growth in the economy, this would send money flooding
into corporations and allow for equity prices to rise even more
relative to earnings. That, of course, depends on the fiscal
cliff, the euro zone, China and any number of other
tough-to-call macro issues.
The downside, of course, is that earnings revert to mean in
terms of their share of overall output. When you track U.S.
wages against profits, you see where most of the expanding share
is coming from.
It may well be, especially if the government is not going to
become much more leveraged, that profits will be limited by wage
growth within a context of low overall growth. That particular
scenario is only an outside chance, but one which would cause a
big fall in shares.
Ultimately, the pie is going to have to grow for equities to
hold their ground, much less gain more.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at
and find more columns at http://blogs.reuters.com/james-saft
)
(Edited by Chelsea Emery)
