On the surface, the S&P 500 third-quarter earnings season is looking pretty good. The S&P 500 is up 25.4% year-to-date and is up 32% year-over-year. So far so good!
By the end of the first week of November, of the 446 companies on the S&P 500 that reported third-quarter results, 73% said they beat their earnings projections. All is well on Wall Street and Main Street! Numbers don't lie! (Source: "Earnings Insight," FactSet web site, November 8, 2013.)
Or do they? That number is pretty solid, at least until you factor in a record 83% of all S&P 500 companies revised their third-quarter earnings guidance lower. It's a little easier to clear a hurdle when you significantly lower the bar. But sadly, not even that was enough for some S&P 500 companies.
What about revenues? Roughly half (52%) were able to beat revenue projections. The percentage of S&P 500 companies that beat revenue estimates is above the fourth-quarter average of 48%—but again, everything is relative. On the other hand, third-quarter sales are below the 59% average recorded over the previous four years.
What do these numbers mean? That a large percentage of S&P 500 companies are reporting better-than-expected earnings on less-than-stellar revenue. That's a pretty tough equation to figure out, unless you toss in cost-cutting measures and share repurchase programs.
It's going to be difficult for S&P 500 companies to continue to wow investors with artificially high earnings if sales remain stagnant. The writing is on the wall.
Of the 85 S&P 500 companies that have issued earnings-per-share (EPS) guidance for the fourth quarter, 73—an eye-watering 86%—have issued negative EPS guidance. Again, it's all relative; the five-year average of S&P 500 companies issuing negative fourth-quarter earnings is just 63%. That's a huge discrepancy by anyone's standards.
And 2014 isn't looking any rosier. The best way to describe U.S. economic growth in 2014 is "tepid." According to some economists, the U.S. should have been able to achieve close to, or even above, 2.5%–3.0%; however, it's been stuck below two percent and is expected to stay there for much of 2014. (Source: "Lukewarm Economic Recovery Expected to Continue in 2014, Says IU Kelley School of Business Forecast," Newswire.com, November 6, 2013.)
These third-quarter results, fourth-quarter projections, and 2014 forecasts should be a wake-up call for investors, not to avoid the stock markets, but rather, to ignore the white noise surrounding propped-up earnings.
While neither exhaustive nor bulletproof, here are a few fundamentally strong companies that have been reporting good revenue growth over the last five years.
Green Mountain Coffee Roasters, Inc. (NASDAQ/GMCR) has reported five-year sales growth near 40% and is up 44% year-to-date. The company announced that third-quarter revenue increased 11% year-over-year, while third-quarter earnings were up 65% at $0.76 per share.
Deckers Outdoor Corporation's (NASDAQ/DECK) five-year sales average is just 16%, and the company is currently trading up 83% year-to-date.
Meanwhile, iGATE Corporation (NASDAQ/IGTE) has reported five-year sales growth near 30% and is up 104% year-to-date. iGATE said that third-quarter revenue increased by 8.2% year-over-year, while earnings climbed 11.1% to $0.30 per share. (Source: "iGATE Reports Strong Third Quarter," iGATE web site, October 10, 2013.)
Sustained earnings growth can only come on the heels of strong sales. In this economy, that's a tough order; unemployment is up, wages are stagnant, and debt levels are high. But with a little due diligence, it is possible to find solid companies bucking the weak sales growth trend.