Forget ‘Earnings’ — Declining Revenue and Dividends the Real Story in Q3

by Jeff Reeves | August 24, 2012 6:00 am

I really am not a pessimist by nature, and I admittedly get a little tired of the “triple top” as an indicator of doom[1] and the crap about how stocks are dead[2]. I am a long-term investor, and right now I am almost fully invested.

However, there’s no denying that there are significant problems ahead for the global economy. As I wrote recently in a recap of PMI stats, manufacturing around the world is in ugly shape[3] — and where there are signs of life, there still aren’t any jobs. The eurozone debt crisis and American “fiscal cliff”[4] are serious obstacles to overcome.

But I don’t want to get lost in the headlines of policy and macoeconomic data points. The biggest concern for investors should be the individual companies they own and their unique risks and opportunities even in these troubled times.

And right now, it’s important to look at two factors above all else: dividends and top-line revenue. Because these two numbers — to me — are the figures that will make or break an equity in 2013.

Dividends As an Indicator

 According to Political Calculations[5], the momentum behind dividend increases has waned and dividend cuts are becoming more frequent. In fact, dividend cuts are at their highest level since 2010, passed only by the horrific period of late 2008 and early 2009 where the financial crisis gutted quarterly distributions at a host of stocks — most notably financials like Bank of America (NYSE:BAC[6]) and Citigroup (NYSE:C[7]), which now pay a mere penny per share per quarter.

dividendincreases Forget 'Earnings'    Declining Revenue and Dividends the Real Story in Q3
Click to Enlarge

There is a clear correlation between an absence of dividends and a hard economic environment. Anyone watching distributions dwindle in 2008 should have heard alarm bells going off that companies were hunkering down for hard times.

Consider recent dividend cuts. J.C. Penney (NYSE:JCP[8]) suspended its dividend[9] amid its rather painful reinvention as a retailer. Much-maligned strip mall store RadioShack (NYSE:RSH[10]) killed its payout, too[11], as did battered grocer SuperValu (NYSE:SVU[12]). All of these businesses have different stories, but share one thing — there aren’t a lot of profits to come by in the current environment, so they are hunkering down to save cash.

Revenue As an Indicator

A host of stocks this quarter have met or exceeded earnings expectations. But profits matter only slightly — the big story right now is the fact that most corporations are seeing bigger profits as they squeeze workers and customers for more cash and cut out costs from their employees and operations.

As InvestorPlace writer Dan Burrows puts it bluntly, the bottom is about to fall out of those earnings as the top line fails to grow[13]. You simply can’t cut your way to growth.

Consider both Hewlett-Packard (NYSE:HPQ[14]) and Dell (NASDAQ:DELL[15]). Both are in the middle of big cost-cutting moves to offset continued slides in revenue[16].

Maybe you want to blame that on the disruptive nature of mobile technology or mismanagement at the dumpster fire that is HP. After all, the company has spent well more than $40 billion in buybacks across the past five years, and the current market cap of the company is only $35 billion right now as the stock hovers at 2005 levels.

Well, how about financial stocks — not the dogs like BofA or Citi, but the “good” ones like Wells Fargo (NYSE:WFC[17]) or JPMorgan Chase (NYSE:JPM[18])? Despite Wells controlling 1 in 3 residential mortgages[19] and the roll-in of Wachovia during the panic of the financial crisis, revenue is tracking just $85.2 billion in fiscal 2012 — the lowest level since 2009, and the top line has been declining each year (and practically every single quarter) since the financial crisis. JPM is in the same boat.

Maybe you want to blame that on the unique problem of banks. OK, fine.

OK, then how about Procter & Gamble (NYSE:PG[20]) that owns huge brands from Oral-B to Mr. Clean to Gillette? It has a five-year revenue growth rate of barely better than 3%. Kimberly Clark (NYSE:KMB[21]), the maker of Huggies and Kleenex, is barely 1%.

No no, you say. Those don’t count because they’re sleepy consumer giants and aren’t supposed to see big growth.

Telecoms like AT&T (NYSE:T[22]) and Sprint (NYSE:S[23]), then. Both are on pace to barely top their 2009 revenue totals this fiscal year.

Same thing. Telecoms aren’t supposed to grow, you say.

What about Johnson & Johnson (NYSE:JNJ[24]) or Merck (NYSE:MRK[25])? Those are both Dow components, and both have a negative five-year annual growth rate for revenue.

Patent expirations, you say!

OK … so then except for blue chips in tech, banking, telecom, consumer goods and health care, then the stock market is doing just fine. Is that your argument?

What to Do?

There are exceptions, of course. A company like McDonald’s (NYSE:MCD[26]) has proven its power through big revenue growth (a five-year annual rate of about 19% on average) and big dividend increases (MCD has doubled its dividend payments in less than a decade). Another recent example would be Apple (NASDAQ:AAPL[27]), which has seen huge revenue growth along with a recently instated dividend payment.

I would encourage investors to seek out blue chips like this to build a stable foundation for your portfolio. If you are banking on a company just because it pays a dividend and has a big name, you could be in for a rude awakening. Given the chart shared earlier, dividends are not bulletproof — just ask General Electric (NYSE:GE[28]) shareholders, or folks who were holding bad banks in 2009.

There are profits to be made by seeking out pockets of strength. But clearly, many companies — in a wide variety of sectors — are struggling to improve their top line.

That doesn’t bode well for the market, or for the economy in general since no businesses will be hiring if they are focused solely on cutting their way to growth.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[29] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. He held a long position in Apple as of this writing, but no other positions in any of the stocks named here.

Endnotes:
  1. “triple top” as an indicator of doom: http://investorplace.com/2012/08/daily-stock-market-news-dow-appears-to-be-forming-a-triple-top/
  2. crap about how stocks are dead: http://investorplace.com/2012/08/stocks-are-dead-cries-a-faithless-bill-gross/
  3. manufacturing around the world is in ugly shape: http://investorplace.com/2012/08/these-4-charts-show-the-ugly-state-of-global-manufacturing/
  4. “fiscal cliff”: http://investorplace.com/2012/08/a-year-after-debt-ceiling-debacle-we-face-bigger-problems/
  5.  According to Political Calculations: http://finance.townhall.com/columnists/politicalcalculations/2012/08/05/declining_dividends_hinting_at_recession
  6. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC
  7. C: http://studio-5.financialcontent.com/investplace/quote?Symbol=C
  8. JCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=JCP
  9. suspended its dividend: http://investorplace.com/2012/08/will-the-j-c-penney-rally-last/
  10. RSH: http://studio-5.financialcontent.com/investplace/quote?Symbol=RSH
  11. killed its payout, too: http://investorplace.com/2012/08/3-rainy-day-dividend-cutters-hoping-to-see-the-sun-ge-pfe-nu-cag-amzn/
  12. SVU: http://studio-5.financialcontent.com/investplace/quote?Symbol=SVU
  13. bottom is about to fall out of those earnings as the top line fails to grow: http://investorplace.com/2012/08/get-ready-the-earnings-floor-is-set-to-fall/
  14. HPQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=HPQ
  15. DELL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DELL
  16. big cost-cutting moves to offset continued slides in revenue: http://investorplace.com/2012/08/dell-hewlett-packard-continue-slow-death-march-to-irrelevence/
  17. WFC: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFC
  18. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  19. Wells controlling 1 in 3 residential mortgages: http://investorplace.com/2012/08/wells-fargo-too-big-to-fail-the-sequel/
  20. PG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PG
  21. KMB: http://studio-5.financialcontent.com/investplace/quote?Symbol=KMB
  22. T: http://studio-5.financialcontent.com/investplace/quote?Symbol=T
  23. S: http://studio-5.financialcontent.com/investplace/quote?Symbol=S
  24. JNJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=JNJ
  25. MRK: http://studio-5.financialcontent.com/investplace/quote?Symbol=MRK
  26. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  27. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  28. GE: http://studio-5.financialcontent.com/investplace/quote?Symbol=GE
  29. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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