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Strong Second Quarter Earnings Can’t Keep the Stock Market Bears at Bay

Stock-Markets / Stock Markets 2010 Aug 06, 2010 - 05:09 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleJon D. Markman writes: The second-quarter earnings season has gotten off to a strong start, but it's been no match for bears who are less than thrilled with future earnings prospects.

More than half of the companies on the Standard & Poor's 500 Index have reported second-quarter earnings results. And so far, they've been strong, with two-thirds of those companies beating earnings estimates, three-fifths beating on sales and almost half beating on both earnings and sales.


As a result, the consensus second-quarter earnings per share estimate has climbed to $20.63 from $19.60 at the beginning of the month. Merrill Lynch analysts expect final second-quarter earnings per share to come in at $20.75 - a 5% sequential improvement from the first quarter.

That would be a deceleration from the 15% sequential growth seen between the fourth quarter of 2009 and the first quarter of 2010, but it's good growth nonetheless. In fact, it puts 2010 S&P 500 earnings at about $83 per share. And at current prices, that gives the market a price-to-earnings multiple of just 13.3-times - below the long-term historical average of 15.

Looking toward 2011, the current consensus estimate for 2011 earnings per share stands at $95.86, which would amount to 15% earnings growth. That would peg the market multiple at 11.5-times. While that pace of growth sounds very optimistic, it's also the average growth rate for the second year of a business cycle expansion.

The bottom line is that stocks have to be considered broadly undervalued at this point so long as U.S. gross domestic product (GDP) growth maintains at least a 3% pace.

Also, large pension funds often are obligated to sell equities and buy bonds to rebalance their exposure at the end of a month in which stocks have performed extremely well.

And boy, have they thrown some favorites overboard.

While second-quarter earnings season has largely been coming in better than expected, the disappointments have led to major takedowns. Just look at what happened to former tech high-flyers like Akamai Technologies Inc. (Nasdaq: AKAM) and NVIDIA Corp. (Nasdaq: NVDA), and consumer icons Kellogg Co. (NYSE: K) and Colgate-Palmolive Co. (NYSE: CL).

Kellogg reported earnings of 89 cents per share, which compares with the consensus estimate of 94 cents. Shares gapped lower before finishing the day with a 6.9% loss last Thursday. That's a huge move for a defensive, low-beta stock like Kellogg. It was the largest one-day loss for the cereal king since November 2008. Ouch.

A similar attack hit Colgate-Palmolive after it beat earnings estimate by a penny but missed on revenues. Shares also gapped lower and finished the day with a loss of 6.8% on huge volume. That's the largest one-day drop for the stock since September 2004.

A drop of a magnitude not seen in six years will seem like an overreaction to bulls. But for those who buy into the notion that a double-dip recession looms on the horizon, any missteps are reason enough to take down earnings multiples.

This is a scenario that we have feared for some time: That earnings would come in fine, but stocks would fall because investors would collectively decide to pay less for future earnings now than they were willing to pay six months ago, shrinking price/earnings (P/E) ratios.

Until now, bears have not been confident enough to mount all-out assaults. But when selling swamps the Colgates and Kelloggs of the world, something is wrong. With breadth still improving, this should be a temporary setback for bulls - as I said, a pause. But consider the hits on Kellogg and Colgate a couple of warning shots and keep it in the back of your mind as August starts to unfold.

Source : http://moneymorning.com/2010/08/06/second-quarter-earnings/

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