Capital Markets

Earnings Surprises Mask Negative Growth

Quarterly net-income figures are coming in higher than many analysts predicted. But almost half of the S&P 500 companies reporting positive surpris...
Stephen TaubAugust 2, 2005

The second quarter is shaping up to be pretty good for corporate earnings. Or so it seems at first glance.

Profits at the Standard & Poor’s 500 companies that have reported their quarterly results thus far came in 13.6 percent higher than they did in the comparable period last year, according to the Associated Press, which cited data from Thomson Financial. As of Monday, 378, or 76 percent, had reported their second-quarter earnings.

That works out to 3.9 percent higher than analysts’ average forecasts, says the report. What’s more, 256 — or more than 69 percent — of the S&P 500 companies that have reported their results have exceeded analyst expectations. The portion of companies beating the Street is the highest percentage since the first quarter of 2004, according to Bloomberg, which noted that typically 59 percent of companies beat their consensus forecasts.

One explanation for the proliferation of positive surprises is that companies set themselves up to easily beat those projections by indicating low expectations to Wall Street. Even so, the data underlying such maneuvers isn’t as rosy as it seems. The moves “seem designed to obscure the fact that fundamentals are eroding,” Richard Bernstein, U.S. strategist at Merrill Lynch & Co., said in a report fired off earlier this week in which he noted that S&P 500 earnings growth has been cut sixfold in the past 12 months.

Further, a fair number of companies failed to beat analysts’ predictions. Fifteen percent, or 57 companies, came in below consensus forecasts, while another 57 reported earnings that merely matched analysts’ estimates, according to the AP.

While Bernstein acknowledges that positive surprises have been more numerous, so is the percentage of companies with negative earnings growth. “Nearly half of the companies reporting positive surprises so far this quarter have slowing profits growth,” he wrote in the report.

There have been only four quarters in the past 14 years during which the relationship between negative earnings growth and positive surprises resembled the second quarter’s, according to Bernstein. “Based on this history, the current combination does not appear to be a healthy one,” he added.

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