Back to the Basics: Focus Shifts to Profits as Earnings Season Starts

By FOXBusiness

After months of focusing on inside baseball in Washington D.C. and the excruciating fiscal cliff, investors can now finally turn their attention to the fundamentals that traditionally influence stock prices: earnings.

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But the question is whether or not investors will like what they hear this earnings season, which kicks off with aluminum maker Alcoa (NYSE:AA) Tuesday evening and really ramps up later in January.

The bulls on Wall Street are hoping fourth-quarter results will show earnings continued to grow after bottoming out in the second quarter even as corporate America grappled in recent months with fiscal uncertainty, Hurricane Sandy and currency headwinds.

Powered by projected double-digit growth from the financial and consumer discretionary sectors, analysts believe fourth-quarter earnings for S&P 500 companies rose by a tepid 3.29% year-over-year, according to McGraw-Hill’s (NYSE:MHP) S&P Capital IQ.

While that represents a serious slowdown from the fourth quarter of 2011 when earnings jumped by a solid 8.35%, it does mark a slight improvement from the third quarter when earnings gained 2.39%.

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“We are not in the clear by any measure but there is a certain confidence about the coming earnings season that seems to speak to an improved global environment for investing,” Peter Kenny, managing director at Knight Capital Group (NYSE:KCG), wrote in a note.

Is 6% Growth Possible?

Investors are relieved analysts are calling for growth at all given the fact that consensus estimates forecasted negative earnings seasons just before Alcoa hit the stage in October and July.

“Out of the box we’re starting out stronger than we were the past two earnings seasons,” said Christine Short, senior manager of corporate earnings at Capital IQ.

Given that S&P 500 companies tend to beat profit forecasts by about three percentage points, Short said  it’s “possible” that earnings growth will hit a “respectable” 5% to 6% once all the numbers are calculated.

That kind of growth would bolster conventional thinking that earnings hit a trough in the second quarter and will continue to grow from there.

Yet as has been the case in recent quarters, Wall Street has been seriously slashing its growth forecasts to reflect the reality on the ground. According to Capital IQ, analysts called for far healthier fourth-quarter EPS growth of 9.6% back on October 1 and robust growth of 14.4% on July 2.

Likewise, earnings forecasts are decidedly back-loaded in 2013, with profits expected to jump almost 10% in the third quarter.

“One can’t help but get the feeling of déjà vu,” Sam Stovall, chief investment strategist at Capital IQ, wrote in a note this week, adding that he can’t “help but wonder if a similar haircut should be expected this year as well.”

'Kitchen Sink' Factor

According to Capital IQ, the fourth quarter traditionally sees the lightest earnings growth of the year, logging an average increase of 5.3% in GAAP earnings since 1936, compared with 9.6% in the first quarter and 9.4% in the other two quarters.

Yet the final quarter of the year also offers the greatest chance for a surprise due to fluctuations caused by one-time charges. Earnings results in the fourth quarter carry a standard deviation of 65.2, more than double the average of 25.7 in the other three quarters, Capital IQ said.

Stovall said this phenomenon is likely due to companies throwing out their financial “kitchen sinks” before year-end.

As for this earnings season, corporate managers had to grapple with a slew of obstacles, headlined by the hated fiscal cliff, which wasn’t resolved until the very last minute.

“Business grew increasingly paralyzed” due to the cliff, Mark Luschini, chief investment strategist at Janney Capital Management, told FOX Business. “You saw headwinds to profit growth due to the fact that business basically began to stall in the second half of 2012.”

Will Banks Offset Industrials?

On top of the fiscal cliff, demand was drained by the devastation caused by Hurricane Sandy in late October and exports were likely hurt by a 2% year-over-year jump in the average value of the U.S. dollar.

This helps explain why fourth-quarter revenues are projected to grow just 3.3%, compared with the 10-year average of 7%.

The industrial sector is among the trouble spots this earnings season, with Wall Street bracing for a decline of 2.6% in EPS.

Short pointed to an expected 14% tumble in earnings from machinery companies amid downbeat forecasts for the likes of Caterpillar (NYSE:CAT) and Ingersoll-Rand (NYSE:IR).

Likewise, the industrial sector could be held down by softer numbers from aerospace and defense companies Boeing (NYSE:BA) and Lockheed Martin (NYSE:LMT).

Information technology companies are expected to suffer a 1.79% decline in fourth-quarter earnings now, compared with estimates for 9% growth back in October. Part of that flip-flop can be attributed to analysts ramping down their projections for on stumbling Apple (NASDAQ:AAPL).

On the upside, the consumer discretionary sector is seen growing fourth-quarter profits 11.73% thanks to the holiday-shopping season. Last week discount giant Target (NYSE:TGT) said it expects to beat consensus earnings estimates despite December same-store sales that flatlined.

Earnings should also be on the rise in the financial sector, where analysts are forecasting a 10.59% increase thanks to strength from big banks.

For example, later this week Wells Fargo (NYSE:WFC) is expected to say fourth-quarter earnings jumped 23%, while profits at Citigroup (NYSE:C) are seen surging 156%.