Earnings Roundup: Everything Old is New Again

Many of the earnings trends for 2012 are likely to remain in place in 2013, raising the prospect of a new year full of slow earnings growth.

On the eve of 2013, logic suggests taking a look back at the old year – 2012 – to revisit some of its major corporate earnings trends and to examine how those themes might develop early in the new year.

Positive Earnings Growth Streak Continues:

Earnings from companies in the S&P 500 index continued to generate positive growth throughout the first three quarters of 2012. The third quarter earnings reporting season is drawing to a close with modest growth in profitability of 0.1%, keeping intact the streak that began in the fourth quarter of 2009. Analysts see no reason for that to change; they are predicting that earnings will continue to expand throughout 2013, as seen below in Exhibit 1. These forecasts of rising earnings suggest that we have just witnessed the trough in the current earnings cycle in the just-ended third quarter of 2012. But it’s too early to take this to the bank. Over the last few months, the rate of growth in these earnings estimates has declined. Given that analysts currently expect companies in the S&P 500 to report growth in profits of less than 3%, it’s not impossible that further cuts to profit estimates or earnings disappointments could bring earnings growth into the red.

Slowing Revenue Growth:

While S&P 500 companies have shown an impressive ability to beat analysts’ earnings estimates, their ability to outperform when it comes to revenue growth has been less worthy of applause. Indeed, revenue growth dropped precipitously in the second quarter, a trend that was followed by a decline in earnings growth rates in the third quarter. Sluggish economic growth in the U.S. made it hard for companies to boost their top-line growth, and foreign sales didn’t expand enough to offset this slump. Despite analysts’ low expectations, S&P 500 companies still struggled to deliver, with close to 60% of companies missing sales forecasts in both the second and third quarters. That’s well above the 38% of S&P 500 companies that fall short of expectations in a typical quarter.

Cost Cutting:

Although revenue growth slowed, S&P 500 companies continued to post positive earnings growth and announce profits that were significantly higher than analysts had estimated throughout 2012. Even in the third quarter of 2012, when revenues declined by 0.8%, these companies actually reported a slight increase in growth. One way that companies were able to maintain earnings growth was by reducing expenses and improving efficiency. Aggregate net profit margins remained remarkably steady and are expected to improve slightly in 2013.

Company Issued Guidance:

Companies traditionally are more bearish than bullish in the guidance they issue to investors, with a track record over the years of 2.4 negative pre announcements to every positive one. That pattern changed somewhat in 2012, however, as the ratio turned even more negative, foreshadowing significant declines in earnings growth estimates in the final weeks of each quarter and the early weeks of the reporting season. (The trend was particularly notable in the second and third quarters of 2012.) Of those companies that cited specific reasons for their downbeat guidance, nearly half pointed to the negative impact of Europe’s economic woes on their own profits. They also frequently mentioned the slower-growth Chinese economy and the strength of the dollar as earnings headwinds. All of these factors remain in place, and all are likely to continue to worry U.S. companies. Not surprisingly, corporate guidance for the fourth quarter of 2012 also is very bearish, with 3.6 negative pre announcements for each positive one.

The confluence of these trends – the increasingly negative earnings guidance, negative revisions to growth estimates, and questions about the ability of companies to further cut expenses – suggests that 2013 could be a year characterized by slow earnings growth. In the absence of any fresh catalysts for profits emerging, it may be reasonable to expect that current estimates for earnings growth in the low- to mid-single digits throughout 2013 may shrink, even though analysts believe that the slowest part of the earnings growth is now behind us.