Do Earnings Misses Matter Anymore?Mar 21, 2013
Chad Karnes, CMT
Do you remember when earnings mattered? So far Wall Street has ignored the fact that 2012 earnings came in lower than 2011's, but how long can they ignore the still very lofty 2013 targets? We suspect full year 2013 earnings estimates will continue to be ratcheted downward.
Fedex and Oracle missed their earnings, and their shares got crushed as a result. The recent earnings misses should remind investors to reevaluate the ambitious 2013 earnings estimates, which are likely flying too high.
The Dominoes start to Fall
On 3/20 FedEx (NYSE:FDX) announced earnings of $1.23B on revenues of $11B. This was short of the $1.38B expected on $10.85B. But what is interesting to us at ETFguide.com is not the earnings miss or even the revenue beat, but the decline in margins, even on a revenue increase.
Actual margins came in at only 11.18% for their third quarter compared to a consensus estimate of 12.72%.
But this was not unexpected to us as we have warned of the sky high Icarus-like earnings estimates for awhile now. Later that evening, Oracle Software (NASDAQGS:ORCL) also missed estimates, coming in with flat earnings on a large revenue miss. It seems the trend of earnings misses may not be isolated.
In a February article entitled, “What do 2013 Earnings and Icarus have in Common?” we warned of the larger macro trend which would make it ever more difficult for companies to hit the perpetual earnings growth the Street expects.
The chart below from S&P (NYSE:MHP) shows the operating earnings estimates for full year 2013 over the past year. Notice a trend?
Fedex and Oracle may now be showing some of the negatives of all time high profit margins, and I suspect we will continue to see earnings ratcheted down as margin growth has now stalled.
The Top Down Earnings
But, it isn’t just 2013 that is too lofty. On February 9, the S&P 500’s full year 2012 reported earnings (NYSEARCA:SPY) were expected to reach a new all time high of $88/share (down from a $90 estimate back in October). But, in a change within the last month, 2012 GAAP earnings are actually going to decline from 2011 (but don’t tell the media because no one likes to talk about earnings declines…or GAAP earnings for that matter).
With 99.2% of companies reporting, 2012 reported earnings are coming in at $86.41, lower than 2011’s $86.95. Think earnings are increasing? Think again, they now have officially swung to negative.
This also makes Dec 31, 2012’s trailing earnings multiple at 16.5x compared to 2011’s equivalent 14.5x, both on the high end of historical multiples.
The below table shows the 2012 earnings decline from 2011 (column 2 & 3) and the ratcheting down of estimates 3.9% since October (column 7).
Estimates Growing into Perpetuity
After the dust has settled, full year 2012 earnings have shrunk from 2011 levels, and 2013 full year earnings are still expected to grow significantly more than 2012. And, earnings are expected to do this even as margins continue to fall for the first time since 2009. We remain skeptical. (Watch our latest VIDEO on "What Trading Volume is Saying about this Market.")
In Oct 2012 with the S&P at 1450 we first identified earnings estimates as being too lofty, but so far the way to play the earnings game has been through short term trades.
We were able to take advantage of the market’s technical decline into November in our Technical Forecast published Oct.10, “If price continues to fall from its high today, then shorts can be opened up with the assumption that 1430 will be visited again.” 1430 was indeed visited again, as was 1374, where we took short profits.
We suspect that as earnings continue to disappoint, a longer-term opportunity on the short side will eventually present itself. When it does the ProShares Short (NYSEARCA:SH) or ProShares UltraPro Short (NYSEARCA:SPXU) ETFs can be used to take advantage of such an opportunity. But timing is key to success.
What’s that you Say about Margins?
Like Icarus, analysts it seems are assuming earnings can go up forever into perpetuity. But in reality, S&P earnings are cyclical and are now starting to slow. They rise and fall over time based on normal macro cycles.
There is easy justification for this cyclicality. When earnings rise, so do margins. When margins rise, competition steps in as barriers to entry are able to be overcome. Competition then puts pressure on pricing. A continued deterioration of margins would certainly bring down full year 2013 estimates and likely share prices.
Icarus Flew Too High, Earnings Too
Earnings margins typically top at stock market peaks (NYSEARCA:IWM) and bottom near market (NYSEARCA:DIA) bottoms. Margins at over 6% are a reason to be cautious, earnings at over 8% where we are now, those are left for Icarus.
Aside from the cyclicality of margins, the upcoming issue of the ETF Profit Strategy Newsletter highlights nine other 2013 mega investment themes along with tradable ETFs to take advantage of the long term market trends. Also published is the Technical Forecast which looks to take advantage of the shorter term market trends across multiple asset classes.
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