Why You Should Finally Pay Attention to Earnings

ETFguide

This week there are some major tech companies reporting earnings.

On Tuesday, Intel (INTC) and Yahoo (YHOO) kicked off the earnings with EBAY (EBAY) and Google (GOOG) following.

This particular quarter’s announcements may be one of the most important since the financial crisis as earnings expectations have gotten flat out ridiculous as Wall Street backs into what is necessary to keep the optics positive.

Any financial analyst worth his salt should recognize the glaring problems concerning 2014 and 2015 earnings estimates.  They are ridiculously lofty compared to recent history.

Is Wall Street Really this Wrong?

Earnings in 2012 for the Tech Sector (XLK) only grew 4% over 2011.  In 2013 this growth rate was just 3%.  These numbers are highlighted in orange in the first half of Figure 1 and show the consensus earnings estimates for the tech sector along with some other analysis I have added.

Now check out the growth numbers Wall Street expects from here on out to 2015.

Figure 1 – Tech Sector Earnings History and Expectations

Tech Earnings July 12 2014

Average growth on a quarterly and yearly basis since 2011 has been less than 2%, yet Wall Street expects us to believe that Tech’s earnings will miraculously climb to an average 18% year over year rate and a 7% average quarterly rate for the next 18 months.

This is shown in the 2 nd half of the table (summarized in yellow).

For 2014, analysts expect a full year 17% jump in earnings from 2013, after only printing 4% in 2012, 3% in 2013 (shown in orange), and 0% the 1Q trailing 12 months.

Such obvious eccentricities are nothing new though.

Lofty Expectations are the Status Quo, used to Dupe Investors

Unmet lofty earnings expectations (VOO) are nothing new and have been going on for years now.  As I warned last year in my article ‘Don’t get Duped’, corporate earnings gaming is par for the course.  Wall Street sets extremely lofty forward earnings (which are never met) in an attempt to convince investors that P/E ratios are low.

By the time earnings actually come in (almost always much lower), the gullible are already looking toward future made up lofty estimates, ignoring the reality the past brought, and focusing instead again on a fictitious estimate.  (Notice in my ‘Don’t get Duped’ article from June 2013 operating earnings estimates at that time were still $118/share.  Know what reality brought by the time 2013 ended? a much lower $107 which resulted in a much higher real P/E ratio than was sold to investors.)

This is why I only use the most recent quarter trailing reported GAAP earnings for P/E analysis.

There’s much less game playing that can be done to history.  Figure 1 above focuses on just the tech sector, but lofty earnings are expected across most sectors, allowing the pundits the ability to continue to quote “low” P/E ratios as rationales you should continue to buy stocks here.

S&P P/E has not been under 15x since 2011’s 20% market pullback

The S&P hasn’t been trading at a 15x multiple or lower for a very long time.  In reality it is trading at 19x today as the table to the left shows in green the S&P’s current consensus GAAP earnings estimates and P/E history.

Listen: Chad Karnes mid-year update on the markets

Figure 2 – S&P P/E Ratio History & Estimates

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PE Ratios
The only way one gets to a 15x multiple today is if 1) you use way forward 2015 estimates and 2) you actually believe those earnings will come in at the extremely high $132, 27% growth in just 18 months from today’s 2014 2Q estimated $104/share.

As shown by Figure 2, in reality earnings have actually only been under 15x for a brief 6 months and only after the 2011 20% pullback in the markets.  If you bought the S&P (IVV) any other period since, reality shows you paid well over 15x for those earnings.

Given first quarter weather problems are now behind us (which retailers such as Wal-Mart (WMT) and the Container Store (TCS) have already admitted was a bogus excuse), this month’s 2Q announcements will go a long way toward end of year estimate “revisions” as there are a lot of expectations for a 2Q rebound from the dismal 1Q.

In the end, earnings will once again be whittled down as the end of the year approaches and reality for the 3 rd year in a row again sets in as this year’s expected $110 of GAAP earnings is likely again too high.

The ETF Profit Strategy Newsletter and Technical Forecast focus on what really matters in the markets.  For the past three years fundamentals have been ignored as earnings growth has slowed, but this hasn’t kept Wall Street from keeping earnings estimates questionably high in order to protect their quoted P/E ratios.  As Wall Street continues to play games with forward earnings, we’re monitoring the market’s technicals and sentiment for the clue the uptrend is finally over.

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