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Lousy Earnings Guidance Makes Stocks Look Bubbly

Corporate profits are on track for record highs, but the outlook for future income is cloudy at best


Bond Market Bubble earnings stock marketThe market likes nothing better than a beat-and-raise earnings report, but this season companies are serving up something more perplexing: Beat-and-lower earnings.

No, it’s not your imagination. Yahoo (YHOO), Intel (INTC), Panera Bread (PNRA) and Stanley Black & Decker (SWK) are just some of the big names surpassing Wall Street profit estimates for the third quarter — but slashing their outlooks.

Stocks are at all-time highs and corporate earnings are on pace for a record, too. Halfway through reporting season, third-quarter earnings per share for the S&P 500 are on track to $26.85, a new quarterly high, notes Goldman Sachs strategist Amanda Sneider. Total earnings per share for the trailing four quarters are also on pace for a record.

The rub is that stocks prices are supposed to reflect future earnings — not profits already on the books from the last quarter or past year. And on that count, estimates for future income are coming down. Fast.

Yes, plenty of companies are beating Wall Street profit forecasts this earnings season. Indeed, the so-called beat rate stands at 75%, according to data from FactSet Research. That’s higher than the four-quarter average of 70% and the four-year average of 73%.

By that measure, earning season has been great so far. Unfortunately, when it comes to future earnings, the season leaves much to be desired.

Q4 Earnings Not Looking So Hot

Despite record earnings in the aggregate, 84% of companies issuing guidance have cut their profit outlooks for the fourth quarter. That, too, is a record — and not the good kind. Over the last five years, on average, only 63% of companies lowered their earnings projections.

As we wrote recently, it’s normal for companies to low-ball their guidance in order to manage Wall Street expectations. The market punishes a company’s stock — at least in the short term — when it misses on earnings. The incentive is to try and get Wall Street forecasts so low that a company can trip over them.

It’s always better to raise guidance — but only to a level management knows it can easily eclipse. This wave of companies cutting guidance points to very real concerns that business is slowing, both sequentially and year-over-year. S&P 500 earnings per share might be staring at a record, but profits are still only 2.3% higher than they were last year.

Much of the trouble stems from tepid top-line growth. The blended revenue growth rate for companies in the S&P 500 stands at just 2% halfway through earnings season. And the top-line beat rate stands at only 52%. That’s much better than the trailing four-quarter average of 48% — but well below the four-year average of 59%.

Corporate sales growth is sluggish. Profit growth is slightly better, but only because of higher margins — and those margins reflect better tax planning and the low interest rate environment more than operational efficiencies.

All of which is a long-winded way of saying the market is looking increasingly pricey — if not overpriced. Hey, that’s what can happen when stocks are rising but forward guidance is coming down. The forward price-to-earnings multiple (P/E) on the S&P 500 stands at 14.7 vs. a 10-year average of 14, according to FactSet. On a cyclically adjusted basis, the market trades at a 50% premium to its long-term average.

Stocks — and valuations — can keep rising for a long time even after they start to look expensive relative to historical averages. That’s how bubbles are made. But they always revert to mean — eventually.

The second-half rebound in earnings the market was looking forward to all spring never did materialize. When it comes to driving share prices higher, sentiment and animal spirits are nice and all — but improving fundamentals would be better.

At some point, this market is going to need accelerating profit growth to justify its increasingly lofty price.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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