With the third quarter earnings reports for the S&P 500 now in, I can update my quarterly analysis of earnings and estimate trends through the 3rd quarter of 2014.
Third quarters results were improved over Q2 as activity continued its rebound following the exceptionally cold winter season. For the quarter, operating earnings rose from $29.34 per share to $29.75 which translates into a quarterly increase of 1.4%.While operating earnings are widely discussed by analysts and the general media; there are many problems with the way in which these earnings are derived due to one-time charges, inclusion/exclusion of material events, share buybacks and accounting gimmickry to “beat earnings.”
Therefore, from a historical valuation perspective, reported earnings are much more relevant in determining market over/undervaluation levels. On a reported basis,earnings improved from $27.14 to $27.64 or 1.84% from the first quarter.
The rise in both operating and reported earnings for the quarter brought the trailing twelve months earnings per share to $114.66 from $111.83, a 2.53% increase, on an operating basis. The trailing twelve month reported earnings rose by $3.01 from $103.12 to $106.13, an increase of 2.92%.
Importantly, the rebound in Q3 earnings is consistent with the rebound/slowdown recovery that has been the hallmark of the economic cycle following the financial crisis. Historically, these large rebounds in earnings have tended to be one-quarter events followed by a marked slowdown in subsequent growth rates.
However, while the headline earnings numbers were strong in the third quarter; digging into the details revealed a bit more troubling picture.
Always Optimistic
There is one commodity that Wall Street always has in abundance, “optimism.” When it comes to earnings expectations, estimates are always higher regardless of the trends of economic data. The problem is that the difference between expectations and reality have been quite dramatic. In a recent missive entitled the “4 Tools Of Corporate Profitability” I stated:
“There is no doubt that corporate profitability has surged from the recessionary lows. However, if I am correct in my assessment, then the recent downturn in corporate profitability may be more than just due to an economic ‘soft patch.' The problem with cost cutting, wage suppression, labor hoarding and stock buybacks, along with a myriad of accounting gimmicks, is that there is a finite limit to their effectiveness. While Goldman Sachs expects profits to surge in the coming years ahead – history suggests something different.”
