With 95% of companies reporting, it looks like Q2 earnings are coming in as expected, around $27 per S&P 500 share. But what does this mean for 2014 and 2015 full year estimates and how does this compare to history?
This week we have a plethora of major retail earnings being released with the expectation of a large rebound from the winter weather driven Q1 downside surprise.
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Big box retailers such as Target (NYSE:TGT), Lowe’s (NYSE:LOW), and Staples (NYSE:SPLS) as well as specialty retailers such as Limited Brands (NYSE:LB) and PetSmart (NASDAQGS:PETM) all report this week as investors expect full year 2014 estimates to remain near the current $119 operating.
This year’s second quarter looks to break away from the historical norm of a declining second quarter from first quarter as 95% of S&P 500 companies have already reported and earnings are coming in around 10% higher quarter over quarter.
But, this year’s earnings profile is in stark contrast to the norm where the first quarter typically grows significantly while the while the second quarter falls. Check out the first graphic below which shows the median quarter over quarter growth in earnings and revenue since the year 2000 for S&P 500 companies. Both second and third quarter typically decline from their prior quarters even though revenues remain in an uptrend.
On a side note, first quarter is extremely interesting as company earnings rise significantly from the year-end even though revenues are at their weakest. Second and third quarters then bring earnings back to accrual accounting earth as they typically decline from first quarter and correct some of the obvious accounting exuberance from Q1.
A look at year over year comparisons, though, shows a more normalized earnings (NYSEARCA:EES) and revenue (NYSEARCA:RWL) profile as all four quarters of revenue and earnings are typically higher than the prior year.
Most earnings are backend loaded as over-accruals and reserves are taken in the first few quarters and “trued up” as the year comes to an end. The revenue profile supports such a claim as earnings are not aligned near as equally as the typical company’s revenue profile.
Economy Remains Historically Slow
Since the year 2000, earnings have grown at an average rate of 7% annually while revenues have grown around 4% each year.
But, as most are now aware, this rate is very front end loaded by the first seven years of the century. Average annual earnings growth since 2007 has been lower, just 2.8% per year, since earnings last peaked in 2007. Revenues are in a similar situation, only up 2.3%/year since the same peak in earnings in 2007. However, if one looks at the last peak in revenues, (revenues last peaked in the third quarter of 2008 while earnings peaked in the second quarter of 2007), revenues are only rising by 1% per year as June’s full year fetches $1,142 per share compared to Sept 2008 which fetched $1,080 per share. The following chart shows this slowed trend since 2007.
Share Buybacks are indeed a Major Reason for Earnings Growth
Of importance is the amount of share buybacks during that time. Based on the recent earnings releases, a full 20% of S&P constituents bought back more than 4% of their shares outstanding over the previous year.
As S&P’s Senior Index Analyst states, “Buybacks are a legitimate use of cash to return value to shareholders”. The problem that he of course does not discuss is that buybacks (as well as cost cutting) can only be done temporarily. Eventually there will be no more costs to cut and there will be no more shares to buy back. What then?
With earnings growing less than 3% per year since 2007’s prior earnings peak and share buybacks accounting for at least 4% of earnings per share for over 20% of companies, share buybacks are now accounting for more EPS growth than actual earnings in many examples. Instead of increasing the numerator (earnings), companies are relying on decreasing the denominator (shares) in order to meet raise earnings per share.
Furthermore, without the buybacks, the 1% revenues per share growth today would be even lower, still below 2008’s peak in revenues as growth remains sizably lower this decade than last decade.
Wall Street continues to assume company earnings and revenues are returning to pre-2007 growth rates, but reality shows this not to be the case.
The ETF Profit Strategy Newsletter keeps you ahead of the game by digging into the fundamentals, technicals, and sentiment levels of the markets. The EPS numbers for 2014-15 continue to assume a major turnaround in the economy, something that has been expected every year since 2009 and something that continues to disappoint as revenues and earnings growth remain well below historical norms.