10.18.14: SP 500 Earnings Update: Forward Growth Rate Nears 2014 High, Despite Energy Drag on Earnings

Per Thomson Reuter’s “This Week in Earnings”, the forward 4-quarter estimate for the SP 500 slipped to $129.34 this week, from last week’s $130.02.

The p.e ratio on the forward estimate 14.5(x), as of Friday’s market close.

The PEG ratio is now 1.54(x), the lowest PEG ratio of 2014, and below the August 1 ’14 PEG of 1.58(x).

The “earnings yield” on the SP 500 after this week’s -1.02% drop in the SP 500 is 6.86%, higher than August 1st’s yield of 6.60% and the highest yield since exactly 52 weeks ago or mid-October ’13’s, 6.81%.

More importantly, the year-over-year (y/y) growth rate of the forward estimate rose for the 2nd week in a row to 9.49%, from last week’s 9.32% and the highest since the early August ’14 peak of 9.58%.

I think there is a real chance we get to a “y/y growth rate” of the forward estimate that hits a new multi-year high in the next few weeks, particularly as Industrial and Technology sectors report their third quarters.

Analysis / Commentary: The bottom callers were out in force this week, which is a pastime I prefer not to practice, but this week’s relative valuation metrics for the SP 500 as denoted by the p.e ratio, the PEG, the earnings yield, and more importantly the resumption  of the forward estimate growth rate to close to 2014 highs, tells me that Wednesday’s low could be the end of this somewhat-different correction. Since 2011, SP 500 corrections have typically lasted 4 – 5 weeks, and have been less than 5% in terms of intensity, while this correction is longer in both duration and severity. There was real, tangible fear in the US stock and Treasury markets Wednesday morning, for the first time in many moons.

We really don’t know though until the SP 500 makes a new high, or exceeds the September ’14 high at the Alibaba IPO of 2,109.26.

A separate post is being prepared on the Energy sector to be published tonight or tomorrow, which I think readers will enjoy, but here is the change in the Energy sector estimates by forward quarter, over the last three weeks: (First column is the week ended October 17th, the 2nd column is the week ended October 10th, and the 3rd column is as of October 1).

Full-year 2015: +4.5%, +5.9%, +6.9%;

Full-year 2014: +5.4%, +6.8%, +7.3%

q3 ’15: +11.3%, +12.0%, +12.7%;

q2 ’15: -2.4%, +1.8%, +2.9%;

q1 ’15: -3.7%, +1.3%, +2.3%

q4 ’14: +0.1%, +4.6%. +6.6%

q3 ’14:  +2.4%, +5.3%, +6.0%

Source: Thomson Reuters “TWIE” weekly missive

What readers should draw from this is the absolute level of the estimate relative to the SP 500, and the rate of change up or down. This is the first time I’ve marked out the data so I am looking at this along with readers, and q1 ’15 has had a 500 basis point (bp) negative swing in its growth rate, and I’m guess the downward revisions will continue through the calendar 4th quarter, particularly as we hear from management’s on q3 ’14 earnings.

We’ve been underweight Energy for two years, but now is the time to do the fundamental homework and prepare for the sector’s outperformance. As John Wooden used to say, “Be quick, but Don’t Hurry”.

Here is one company example: Baker-Hughes (BHI), reported q3 ’14 earnings on Thursday, missing on both the consensus revenue and EPS estimates for q3 ’14 materially, for the first time since the 3rd quarter, 2012. BHI’s full year 2015 consensus EPS estimate as of the July ’14 earnings report was $5.55, after Thursday’s report the full-year 2015 consensus EPS estimate was reduced to $5.10, or a 10% reduction in just the last 3 months.

I actually like BHI as well as HAL and SLB, but the oil service companies are “leveraged” plays on crude. We’ll have more on a separate post on Energy coming tonight or tomorrow.

To conclude this Weekly Earnings Update, while the mainstream financial media loves to talk Ebola, the bigger issue could be Europe. John Butters of Factset, published a very interesting table this week, with Factset’s weekly earnings analysis: of the 68 SP 500 companies that reported q3 ’14 earnings this week, 44 of the 68 cited “Europe” as an issue during the quarterly conference calls. 38 of the 68 cited “forex” or likely US dollar strength, while 25 companies cited “China” as an issue this quarter, just 7 were specifically negative, and only 6 companies cited Ebola.

The point for Fundamentalis readers is that despite what is in the headlines, it is “attribution” that is more important. I would also add that what management’s say in terms of “color” on the conference calls, isn’t necessarily what the analyst’s “attribute” upside and misses to, when gauging how individual companies performed relative to their models. E.g. a individual company misses on consensus revenues but beats on consensus EPS, and the analyst reports that are published post-conference call, note that “currency” drove the 2% revenue miss, but a lower-than-expected tax rate, or a higher than expected operating margin thanks to SG&A reductions drove the EPS upside.

Greg Harrison of Thomson Reuters and John Butters of Factset (John used to do Greg’s job at Thomson Reuters, and now does the same work at Factset) do great work in providing readers with earnings commentary. These reports are free too by the way. All readers have to do is sign up. The work that I do is to model the data over long periods of time that T/R and Factset provide and try to provide additional color and analysis. Doing this work, keeps me focused on earnings for clients and ultimately has an impact on investing decisions. You have to roll up your sleeves and do the work, though.

125 – 130 more companies report q3 ’14 earnings this week. I am staying with our original forecast that outside of Energy, I think the SP 500 earnings will come in at a high-single-digit, possibly 10% growth rate on an operating basis, and be a positive catalyst for the stock market.

Q4 ’14 expected earnings growth for the SP 500 is 10% as of Friday, 10/17. There is always downward pressure on the current quarter’s estimate, but this week will give us a better feel for non-Energy sector guidance.

Thanks for reading and stopping by. We’ll be out with more articles tonight or tomorrow.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager




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