Earnings outlook might be less rosy than investors think

By Reuters

Nov 08, 2014 06:57 PM EST

With the U.S. third-quarter earnings season almost at an end, many investors are breathing a sigh of relief as more companies surpassed profit expectations than in any quarter since 2010.

But some analysts say investors may be brushing off their worries about corporate profits a little too soon.

While most Standard & Poor's 500 companies beat analysts' expectations for third-quarter earnings, many just barely topped estimates, said Pankaj Patel, head of quantitative research at Evercore ISI in New York.

Of the S&P 500 companies that had reported results as of early this week, 66 percent exceeded expectations, according to Evercore's data analysis. But that figure falls to just 43 percent after stripping away companies that beat expectations by 5 percent or less, Patel's research shows.

The figure excluding beats of 5 percent or less is also well below the percentage of beats according to data based on Thomson Reuters I/B/E/S polls of analysts. On that data, 74 percent of S&P 500 companies so far have exceeded analysts' expectations, which is the highest for any quarter since the second quarter of 2010. Results have come in from 88 percent of the S&P 500.

The results could mean that an increasing number of companies are trying to "manage their beat rate," possibly to mask profit weakness, Patel said, noting that companies that exceed expectations by 5 percent or less typically see their share prices decline in the three days following results.

"The beat rate is artificially high, but people still watch that percent," Patel said. "They keep buying and the market goes higher."

The S&P 500 has risen more than 3 percent since Oct. 8, roughly when this earnings season began. The index is up 9.1 percent from its Oct. 15 low.

In addition, analysts' keep trimming their profit forecasts. Estimates for fourth-quarter earnings are down from the start of the quarter, along with estimates for the first part of 2015.

Earnings growth for the fourth quarter now is estimated at 7.6 percent compared with an Oct. 1 forecast for 11.1 percent growth, Thomson Reuters data showed. For the 2015 first quarter, profit growth is seen at 8.8 percent, down from an Oct. 1 forecast for 11.5 percent growth.

Moreover, the magnitude by which fourth-quarter estimates are falling has increased compared with the previous quarter, said Nick Raich, chief executive officer of The Earnings Scout, a Cleveland-based independent research firm specializing in earnings trends.

In outlooks given by companies themselves - done by only a minority of companies - the news is not good. Negative outlooks outnumber positive ones for the fourth quarter so far by a ratio of 3.9 to 1, up from the third quarter's ratio of 3.3 to 1, Thomson Reuters data showed.

"That's a worsening trend," Raich said. "The outlooks have gotten a little bit worse this quarter."

Outlooks could become even dimmer if lackluster demand overseas translates into weak results for the fourth quarter.

"The United States clearly is the bright spot in the world," said Uri Landesman, president of Platinum Partners in New York. "The rest of the world isn't nearly as strong, so demand coming from certain places is weaker, and the currency is going to have an enormous impact going forward."

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