It's not the companies, but the analysts who are getting it wrong this earnings season, according to a report by Citigroup Smith Barney.
“Inflexibly robust” earnings targets among equity analysts are the reason more companies are not beating expectations for the fourth quarter, according to a note the investment bank sent to clients on Monday. In some sectors, targets for 2005 need to be pared down to reflect the reality of slowing profit gains.
“If earnings releases for last year's final quarter haven't vastly exceeded estimates with the gusto of the last two years, don't blame ephemeral targets like ‘macro conditions': blame the estimates,” Smith Barney senior economist Steven Wieting wrote in a Friday note to clients. “Comparisons across many cyclical businesses have become much more difficult, yet estimates for last quarter seemed inflexibly robust.”
Earnings targets among companies in the industrial, consumer discretionary and financial sectors look upbeat on “difficult comparisons” with year-earlier results, but the materials sector is particularly vulnerable to having their earnings forecasts slashed by analysts in early 2005 given that commodity prices have stopped soaring, Mr. Wieting said.
Industrial commodity prices rose 10 per cent in the fourth quarter from a year ago, which would be consistent with a 50-per-cent jump in profits for materials companies. However, Mr. Wieting said that a consensus targets from analysts is for growth of 72 per cent and that “current estimates for companies yet to report may still be at risk.”
Operating profits — which have risen about 65 per cent from their bottom three years ago — have been on a remarkable run. “Pretty impressive,” Mr. Wieting said, “but instead of setting the bar lower, the estimates of analysts in the latest quarter looked for even more.”
Analysts agree that corporate earnings have begun to decelerate from four straight quarters of plus-20-per-cent earnings growth. According to Thomson First Call, profit among companies listed on the S&P 500 composite index are set to rise 16.5 per cent in the fourth quarter, on top of year earlier growth of 28.3 per cent — the highest quarterly growth rate in a decade. (Mr. Wieting expects earnings per share will rise 12 per cent in the fourth quarter.)
From then on, First Call predicts profit growth will simmer down to 7.3 per cent in the first quarter of 2005, 8 per cent in the second quarter, crept up to 13. 1 per cent in the third and 12 per cent in the fourth.
Although the earnings slowdown was expected, the current season has taken on a negative tone. U.S. stocks are coming off their worst three-week opening for any year since 1982, and closed lower on Monday.
The notion that profits are not going to jump 15- to 20 per cent each quarter should not come as a surprise, Mr. Wieting said. He points out that earnings will continue to grow, just at a slower pace than we have been spoiled by in recent quarters.
Earnings estimates for the first and second quarters of 2005 are more easily reachable, especially if the current quarter spurs some downward earnings revisions, he said. If that happens, “it seems more likely that many earnings results reported in the spring and summer periods will compared more favourably against estimates.”
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