Better than Expected

• By Dirk Van Dijk
• On 1:00 am EDT, Wednesday October 21, 2009

Earnings Trends Key Points:

• Earnings surprise ratio (#beat / #miss) at 5.56
• Median Earnings Surprise 7.90%
• Year-over-year earnings growth ratio (# Positive Growth/# Negative Growth) at 0.74
• Sales surprise ratio at 2.0
• Sales growth ratio at just 0.35
• Total net income for S&P 500 reported firms is 12.1%. This is above what those same 66 firms reported a year ago and 4.9% above what they earned in Q209
• Total S&P 500 revenues reported down 4.7% year over year, off 0.16% from Q209.
• 2009 earnings revisions ratio for full S&P 500 up to 2.31, from 1.85
• Revenue revisions ratio at 1.63 for 2009

Welcome to the new Earnings Trends. Our analysis of the S&P 500 will now use Zack's own sector groupings rather than the S&P GICS sectors. There are 16 Zacks sectors and only 10 GICS sectors, so the change will result in better granularity of the data. (The old way simply grouped too many very different companies together.) In addition, we will now present top line as well as bottom line expectations and surprise information. This is very much or a work in progress, and we will be adding additional information, tables and perhaps even some graphs over the next few months.

Since we are in the heart of earnings season, we will first focus on the quarterly data for those firms that have already reported. We will add more annual information in the weeks to come.

The overall picture is very similar to the second quarter with most firms beating both earnings and revenues expectation, but both the top and bottom lines are lower than a year ago. As far as the surprises are concerned, firms are doing better on the bottom line than on the top line. Of the 66 firms that have reported so far, 50 have come in with EPS that are higher than expected, while only 9 have disappointed, a ratio of 5.56:1. While firms have long tried to under-promise and over-deliver, the normal ratio has been about 3:1 positive to negative (over the last five years or so), so this definitely counts as a better than normal bottom line earnings season so far.

The median earnings surprise is a very strong 7.9%. (Normally the median surprise runs at about 3%.) However, this is in large part a triumph of low expectations. There are 38 companies with earnings that are lower than a year ago while only 28 have seen positive year-over-year growth.

The disparity between firms beating estimates, but having negative year-over-year earnings growth is particularly noticeable in Tech, where the earnings surprise ratio is a huge 10, but the growth ratio is just 0.36. A similar situation, but not quite as extreme, is true for Retailers. Staples and Medical have been both growing earnings and beating expectations.

On the top line, it has also been a successful season so far relative to expectations. In terms of actual year-over-year growth, however, it has been downright ugly. The total revenues of the 66 firms that have already reported are 4.6% below year ago levels. A total of 44 firms have reported higher-than-expected revenues, versus only 22 that have disappointed, for a ratio of 2.0. On the other hand, only 17 actually had higher sales than a year ago, versus 49 with lower revenues.

For the market as a whole, but especially for Tech, the better than expected, but worse than a year ago story also applies to revenues. While only 13.3% of the Tech firms have actually grown revenues from a year ago, 86.7% have seen revenues drop. Still, the expectations were set very low on the revenue side. As a result, 86.7% of them have exceeded expectations and only 13.3% have fallen short.

For the S&P 500 as a whole, 23.3% of reported companies have generated positive year-over-year revenue growth, while 76.7% have seen revenue declines. However, 66.0% have exceeded revenue expectations, while 34.0% have fallen short.

In other words, cost cutting has been the major force driving earnings. However, the costs to one company are either the revenues of another company, or someone's paycheck, which is then spent to create revenues for firms. Still, the strategy seems to be working as earnings are coming in much better than expected and analysts have responded by increasing earnings estimates for 2009. The estimate increases are widespread across sectors, with 6 sectors seeing more than 4 increases for each cut, while only 2 sectors, Utilities and Aerospace, seeing more cuts than increases.

For the S&P 500 as a whole the revisions ratio now stands at 2.31, its highest level in over a year. The current ratio is also in distinct contrast to earlier in the year when it fell below 0.15 at one point.

Scorecard & Earnings Surprise

• Still early, just over one in five reports in
• Data presented reflects only firms that have reported so far
• Early reports extremely positive
• Earnings Surprise ratio (#beat/#miss) at 5.56
• Tech perfect with 10 beats and no misses; Medical strong at 13:1
• Median Earnings Surprise is 8.70%, a very strong reading
• Very skewed sample, no Aerospace or Utilities, but over 20% of 3 sectors
• Year over year Earnings Growth ratio (# Positive Growth/# Negative Growth) at 0.74
• Staples and Finance only sectors with more positive growth firms than negative growth

In evaluating the data presented here, keep the % reported in mind, especially since the sample size for some sectors is extremely small. The move to the 16 Zacks sectors means that even when all reports are in, some of the sectors will still have relatively few firms in them. For sectors with only a few reports in, the median surprise will be very volatile as new companies are added to the sample. Thus, the 76.7% median surprise in Basic Materials is probably less significant than the 15.15% surprise in Consumer Staples, especially when you consider that the consensus is usually much tighter for Staples firms than for materials firms.

Some of the more impressive earnings surprises in staples include General Mills (NYSE: GIS - News), Constellation Brands (NYSE: STZ - News) and Campbell Soup (NYSE: CPB - News). Tech has also had a number of impressive earnings surprises including Intel (NasdaqGS: INTC - News) and National Semiconductor (NYSE: NSM - News).

Sales Surprises

• Sales Surprise Ratio at 2.0
• Staples missing on sales even as they beat on earnings
• Tech looks terrific with a 6:1 positive sales surprise ratio
• Sales growth ratio at just 0.35
• Most Tech firms have declining sales, but less of a drop than expected

Reported Growth: Total Net Income

• Massive growth in Financials due to low year ago base, earnings down from Q209
• Will be a more extreme issue in the fourth quarter
• Total net income for the S&P 500 reported so far is 12.11% above what those same 66 firms reported a year ago and 4.86% above what they earned in Q209
• Year-over-year growth is sharply negative for Materials in Q3, but is expected to turn very positive in Q4

Reported Growth: Total Revenues

• Total S&P 500 revenues are down 4.66% year-over-year, but only off 1.59% from Q209
• Only financials show positive year-over-year revenue growth
• Consumer Discretionary revenue growth up 29.3% from Q209, but down 13.2% from year ago
• Seasonality can greatly affect sequential growth, but year ago was unusual and may be distorting year-over-year figures
• Revenue growth expected to turn positive, on both a sequential (3.0%) and year-over-year basis (9.7%) in Q4. Financials will mostly account for the year-over-year growth in Q4.

Revisions: Earnings - The Zacks Revisions Ratio: 2009

• Revisions ratio for full S&P 500 up to 2.31, from 1.85
• Positive surprises translating to estimate increases for 2009
• Six sectors seeing more than 4 estimate increases for each cut
• Only Utilities and Aerospace seeing estimates cut on balance
• Utilities and Aerospace continue to see estimates cut
• Ratio of firms with rising to falling mean estimates climbs to 1.90 from 1.44
• Total number of revisions (4-week total) up to 2,099 from 1,537 last week (36.6%)
• Increases up to 1,465 from 998 (46.2%); cuts up to 634 from 539 (17.6%)
• Total revisions activity will rise dramatically over next few weeks

Analysts are responding to better than expected Q3 earnings by raising 2009 estimates almost across the board. Unlike the data presented above for the surprises, the revisions data is for all 500 firms in the index. Total revisions activity has picked up dramatically, and will continue to do so over the next few weeks, as it always happens during earnings season.

The broad increases in earnings estimates seem to reflect a much better short-term outlook for the economy. Note that some of the most cyclical areas such as Retailers, Materials and Autos are seeing a large preponderance of upward over downward earnings revisions, and that most of the firms in those sectors are seeing their consensus estimates increase.

Revisions: Revenues - The Zacks Revenue Revisions Ratio: 2009

• Revenue Revisions Ratio at 1.63 for 2009
• Firms with higher revenue estimates outnumber firms with falling revenue estimates by 1.78:1
• 13 sectors see net positive revenue revisions and only three are negative
• Big divergence between positive earnings revisions for Discretionary and slightly more revenue estimate cuts
• Average increase in revenue estimates for the S&P 500 firms is 0.33%.

Data in this report, unless stated otherwise, is through the close on Thursday 10/16/2009

GENL MILLS (GIS): Free Stock Analysis Report

CONSTELLATN BRD (STZ): Free Stock Analysis Report

CAMPBELL SOUP (CPB): Free Stock Analysis Report

INTEL CORP (INTC): Free Stock Analysis Report

NATL SEMICON (NSM): Free Stock Analysis Report

Zacks Investment Research

ADVERTISEMENT  Zacks Investment Research FREE: 4 Stock Picks Every Day This system triples the S&P 500. Get Picks Now >>