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Are Earnings Expectations Too High on Wall Street?

Companies may hit numbers, but may not see shares pop


With Alcoa (NYSE: AA) posting mixed Q410 results after the bell on Monday and Intel (NASDAQ: INTC) posting a fourth-quarter earnings jump of 48%, earnings season is now in full swing. Over the next month, 71% of the companies in the S&P 500 will report results. With investors expectations so high, can the corporate sector deliver? We’ll find out soon, as the the chart below shows how the bulk of reporting will happen the week of January 24.

earnings chart 1

Year-over-year earnings growth expectations stand at 30.7% according to Credit Suisse analysts — which will happen only if companies manage to expand their profit margins further. Although Alcoa managed to do exactly that — by missing revenue estimates but beating on the profit line — it will become harder and harder as labor productivity gets maxed out, additional factory capacity must be put back into action, and new hiring takes place.

earnings 2

As a result, earnings growth rates are expected to slow dramatically heading into 2011, falling by more than 50% over the next quarter. And unlike the Q1, Q2, and Q3 reporting seasons, analysts aren’t increasing their earnings estimates as the reporting season gets started.

The more optimistic will say that this is setting the market up for upside surprise; but it has a lot to do with the difficulty of really surprising analysts with profit margins pretty much maxed out. With revenue growth also leveling off, the impressive year-over-year growth rates we’ve enjoyed recently will diminish as we transition from a zoomy period economic recovery (returning to 2007 levels of output) to the slower pace of economic expansion (pushing to new levels of output).

Because off all this, I think the current reporting season will be less of a positive factor than it’s been over the last two years. And that suggests that now is the time to look at booking profits and preparing for a period of market weakness in the days and weeks to come.

If you’re looking for short ideas, the Credit Suisse team compiled a list of companies that have issued negative earnings guidance and are set to disappoint. The list includes steelmakers AK Steel (NYSE: AKS) and U.S. Steel (NYSE: X), furniture maker Leggett & Platt (NYSE: LEG), and power producer AES (NYSE: AES).

Be sure to check out Anthony’s new investment advisory service, The Edge. A special free trial has been extended to readers. Log in using the following credentials: user name: trial; password: edge. The author can be contacted at Feel free to comment below.

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