S&P 500 Corporate Earnings Beating Estimates

By: Hans_Wagner

To the surprise of many, the first quarter 2010 earnings for many S&P 500 companies are beating estimates, some substantially. If this is an indication of greater strength in the economy, does this mean the market rally will continue?

Analysts are behind the curve in raising their earnings estimates during the recovery. For example, over the last year quarterly earnings has surprised to the upside between 6 and 13 percent according to Thompson Reuters.

The surprise in earnings to the up side makes sense. During the recession, companies were quick to reduce their expenses when the economy crashed. As the economy recovers, companies have been slow to increase hiring and they are controlling other expenditures. As a result, margins remain strong leading to better earnings than many thought possible.

Corporate revenues are also growing as companies find quality sales opportunities from the emerging markets as well as from the pent up demand in North America. However, the financial sector is contributing a substantial portion of the growth in revenues as it recovers from the drubbing they received a year ago.

With 98 of the S&P 500 companies reporting, 85 percent of the companies have beaten analyst’s expectations according to Bloomberg. This compares to 61 percent that has been typical in recent quarters.

Even more surprising, 70 percent of these companies beat revenue estimates. Of course, we are still early in the earnings season, so the numbers can come down. However, it indicates that companies are growing the top line as well as the bottom line.

In a recent article on predicting the 2010 and 2011 S&P 500, I used the Standard & Poor’s estimates as a guideline. As noted in the article, these estimates have been rising each quarter, as the economic recover proves more robust than many thought. It looks like once again the actual results will beat the estimates.

For the first quarter 2010 the trailing four quarters as reported earnings estimate for the S&P 500 was $59.44 with the first quarter’s earnings coming in at $15.81 for the quarter. While it is early to make a refined forecast, so far the results indicated earnings would be higher than estimated once again. For the 98 companies that have reported, earnings are coming in are slightly more than 13 percent higher than estimated. This helps to power the market higher.

Below is a table from an article I wrote recently on the S&P 500 PE ratio and the forecast for the market. What if earnings for the first quarter of 2010 come in 5 percent higher than expected? This will bring the as reported earnings for the S&P 500 up $0.79 for the quarter. Should the earnings for the quarter come in at 10 percent higher forecast, we would see $1.58 in additional earnings for the quarter or $61.04 for the S&P 500 trailing as reported earnings.

The current PE ratio for the S&P 500 trailing reported earnings is approximately 20. If we assume the first quarter 2010 earnings will come in 10 percent higher than forecast by Standard & Poor’s, the estimate for the S&P 500 is 1,220. On Friday April 23, 2010, the S&P 500 closed at 1,217.

Table from Article titled “S&P 500 PE Ratio - Forecast 2010 – 2011”

The market is always looking ahead. Since revenues and earnings are beating estimates, it indicates the economy is performing better than many thought. The high levels of unemployment (9.7%) and under employment (16.5%) are keeping the economy back from growing faster. However, people are willing to spend, especially those with secure jobs. In addition, companies are investing in their businesses, contributing to the higher growth of the economy. This pattern of more spending and higher than expected economic activity encourages investors to believe the market will move higher.

Of course, the estimate that earnings will come in 10 percent higher for the quarter is just that, an estimate. We need to monitor the earnings releases during the next several weeks to get a better idea of how much the first quarter’s earnings results will exceed the estimate. If the current pattern holds, the market will continue to rise based on its fundamentals. Since this is the most likely case, we should raise our expectations that earnings will grow faster than many expect as the economy recovers.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2010 Hans Wagner

If you wish to learn more on evaluating the market cycles, I suggest you read:

Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joe Ellis is an excellent book on how to predict macro moves of the market.

Unexpected Returns: Understanding Secular Stock Market Cycles by Ed Easterling.  One of the best, easy-to-read, study of stock market cycles of which I know.

The Disciplined Trader: Developing Winning Attitudes by Mark Douglas.  Controlling ones attitudes and emotions are crucial if you are to be a successful trader.

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