On the surface, the fourth-quarter earnings season was a triumph for companies in the Standard & Poor’s 500-stock index. Collectively, 63% of them beat analysts’ estimates for the quarter, slightly topping the long-term average of 62%. But that apparently upbeat headline number masks a more disappointing reality: the fact that many of the companies that ostensibly beat forecasts actually were exceeding estimates that had been revised downward over the course of the quarter. Then there is the fact that fourth-quarter earnings for S&P 500 companies rose 9.4%, dipping back into the single digits for the first time after eight straight quarters of double-digit earnings growth. The aggregate difference between actual earnings and analysts’ estimates immediately prior to the release of those earnings was 3.7%, higher than the long-term average of 2.7%. Again, while that may look impressive at first blush, put in a broader context it’s underwhelming: it’s the lowest figure recorded since the fourth quarter of 2008, and much lower than the 6.1% we have seen over the past four quarters. And corporate executives made some dismayingly bearish comments about their prospects for the soon-to-end first quarter.
The chart below breaks the surprise data down by sector, illustrating the sources of strength and weakness throughout the index. As can be seen clearly here, industrial and technology companies were the biggest winners, posting earnings growth of 17.7% and 17.3%, respectively. Among industrials, 75% of companies were able to translate better global economic growth into higher-than-forecast earnings, with Caterpillar Inc (CAT.N), Boeing Company (BA.N), and Cummins (CMI.N), all noting increased growth prospects during their earnings conference calls. Within the technology sector, Apple Inc. (AAPL.O) had the largest positive earnings surprise in dollar terms, beating its net income estimate by $3.4 billion, en route to becoming the largest company in the world in terms of market capitalization. Apple’s results alone were enough to boost the S&P 500 index growth rate by 3.1 percentage points, but it wasn’t the only tech company to reward investors with a big positive surprise. Motorola Mobility Holdings Incorporated (MMI.N), Computer Sciences Corporation (CSC.N), and Western Digital Corporation (WDC.N) each beat their earnings estimates by more than 100%.
Exhibit 1: Q4 2011 Percentage Difference: Actual vs. Estimates
Source: Thomson ONE
The losers included companies in the Telecommunications Services sector, the worst fourth-quarter performer. Four of the seven companies in the sector missed their earnings estimates, and profits for the group shrank 22.8%. Among the losers was AT&T Incorporated (T.N), hurt by the withdrawal of its bid for private company T-Mobile USA, Incorporated and the associated $4 billion breakup fee. The Materials sector also had a very difficult fourth quarter due to lower commodity prices. Last October, analysts expected the group to see fourth-quarter earnings grow 25.6%; instead, they contracted, falling 14.1%, led by bellwethers like Alcoa Inc. (AA.N) and United States Steel Corp. (X.N).
More unnerving than the mediocre fourth-quarter earnings growth is the fact that a majority of S&P 500 companies that have issued guidance for first quarter earnings have been pessimistic; for every positive forecast, companies issued 2.9 negative earnings preannouncements. That is significantly higher than the long-term average of 2.3, and is the worst preannouncement level recorded since the first quarter of 2009. This negativity is especially disappointing when we consider that analysts have already cut their earnings expectations for the S&P 500 companies: Last October, they were expecting 10.2% growth but today, only a few weeks away from the date most companies will close the books on the quarter, that estimate is only 3%.
Once again, it pays to look beyond the headline number and scrutinize the sector-specific forecast. Here, a different and more diverse picture emerges. In the case of technology companies and the Consumer Discretionary sector, the outlook appears less negative than the long-term average. At the other extreme, several sectors don’t have a single company offering positive earnings guidance, as shown in the chart below.
Exhibit 2: Q1 2012 Company Issued Guidance
Source: Thomson ONE
The Information Technology sector can boast a solid if not spectacular estimated earnings growth rate of 5.2%, impressive in the context of the overall forecast of 3%. (The sector has the strongest negative to positive preannouncements ratio in the index, with a N/P ratio of 1.3.) Apple is once again the leader: its management expects earnings to hit $8.50 a share, above the $8.03 estimate at the time the guidance was issued, thanks to record of the iPhone 4S and the prospect that its newest iPad will be released before the end of the quarter. Western Digital Corporation (WDC.N) guided estimates higher, suggesting it will earn $1.30 a share compared to previous estimates of 91 cents a share; the company’s manufacturing facilities in Thailand are recovery more rapidly than anticipated following devastating floods in that country last year. That’s bad news for Western Digital customers like Hewlett Packard, which guided estimates lower, referring specifically to a disk drive shortage that it says will hurt both volume and margins.
The Health Care sector appears to be facing serious difficulties, with an estimated growth rate of a measly 0.3%, and virtually every company within the group telling investors they may not even be able to meet those lowball estimates. Not a single company in this group has issued higher earnings guidance; 14, meanwhile, have warned that their results may fall short. A majority of health care companies that provided guidance manufacture medical devices, sell laboratory equipment, or distribute health care products, and the reasons they cite for the probable earnings shortfall vary from a weak macroeconomic environment and slowdowns in Europe and Asia, to foreign exchange headwinds. Whatever the reason, management teams in this sector are signaling that they may be in for a rough quarter.
For the full wrap-up report of the just-completed earnings season, and a lookahead to the first-quarter results, please see the full report here.
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