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Q3 Earnings Begin Tomorrow: Are Earnings Estimates Still Too High?


Poor Alcoa (AA). At $10 billion, the once-biggest aluminum producer in the world is now worth about 20% less than Whole Foods (WFM) and was recently trading at a two-year low. Even if Alcoa hits the street consensus Q3 EPS estimate of $0.23, investors are likely to yawn, ambivalent to the improvement that would imply from the $0.09 it reported a year ago.

But on Wall Street, it's not about a year ago, it's about a year from now, and on that front, investors aren't waiting around for analysts to confirm what they already know, and have cut Alcoa's stock in half.

Even so, Alcoa's 2012 EPS estimate is still baking in 22% EPS growth next year and that figure has already come down 20% in six months, according to FactSet.

In the attached clip, Macke and I discuss the high probability that not just Alcoa, but all earnings estimates for the foreseeable future are too high. While that belief is widely held, gauging how much of a profit drop is already factored in to a particular stock is the clear and present danger, as well as an enormous opportunity.

My point is, at $9 a share, the risk in Alcoa now is that they under-disappoint (yes I just made that word up, but it's true). It's also why I think it will be important to see how the market reacts when the smallest member of the Dow Jones Industrials reports after the close tomorrow. As you know, earnings are not a game of absolute performance, they are a game of relative performance based on existing expectations.

As it stands, FactSet Earnings Analyst John Butters' latest report shows Q3 estimates for the S&P 500 have fallen by 3.9% in the past three months, with half of that reduction coming from the financial sector alone (which itself suffered an outsized impact at the hands of a single stock - Goldman Sachs (GS)). Butters reports that estimates on the world's preeminent investment banks went from $3.62 on June 30 to just $0.23 today and that without Goldman, estimates for the financial sector would go to 13% from the 8.3% that is expected.

So, as much as Alcoa will lead the parade in week one of earnings season, Pepsi (PEP), JPMorgan (JPM), Safeway (SWY), Google (GOOG) and JB Hunt (JBHT) will be close behind and shed important insights from some other key parts of the domestic and global economies.