Call the quarter grim but not disappointing. Which is good news as a whole for an earnings season with expectations for a 7% or larger drop in earnings for the stocks in the Standard & Poor’s 500.
This morning JPMorgan Chase (JPM) reported earnings of $1.35 a share,down 6.7% from the first quarter of 205. Revenue dropped 3%.
But both earnings per share and revenue beat Wall Street’s projections. Wall Street was looking for a 13.4% drop in earnings–so a decline of just 6.7% seemed remarkably positive. Revenue had been estimated to fall to $23.8 billion, so a fall to $24.1 billion also seemed to be positive news.
The shares closed up 4.23% today to $61.79 as both the Dow Jones Industrial Average and the Standard and Poor’s 500 rose (by 1.06% and 1%, respectively.) Before today’s rebound shares of JPMorgan Chase had been down 10% for 2016.
The beat on earnings was largely a result of cuts to expenses–and to trading revenue not being as terrible as the bank had warned in February. Non-interest expenses were down 7% on lower compensation paid to investment bankers and traders and lower legal cods. Pay in the investment banking business fell 14%, dropping more than $420 million from the first quarter of 2015. That month JPMorgan Chase had warned that markets revenue would drop by 20%. In actuality fixed-income trading dropped only 13% and equity trading dropped just 5%.
Looking ahead the bank flagged continue problems in its energy loan portfolio. JPMorgan Chase added $529 million to its loan loss provisions for oil, natural gas, and energy pipelines. That took the total loan loss provision for energy loans to $1.3 billion. The bank had told analysts to look for a $500 million addition to the loan loss provision for its energy portfolio. The bank also set aside $162 million to cover potential losses in its metals and mining portfolio. In February JPMorgan Chase had estimated that it would add $100 million to loan loss provisions for this part of its portfolio.
Wall Street estimates say the first quarter earnings season that officially begins on Monday when Alcoa (AA) reports its results after the close will show a year over year drop in earnings per share for the Standard & Poor’s 500 of somewhere around 7% to 7.4%.
As I wrote in my March 31 post http://jubakpicks-1565237904.us-west-2.elb.amazonaws.com/2016/03/31/how-big-is-the-stock-markets-earnings-problem/ that forecast doesn’t mean we’re looking at a significant sell off in U.S. stocks even though the S&P 500 index is near the record high set back in May 2015 and at 2050 today, April 8, stands near the top of its recent trading range.
The trend in the market as a whole “depends” and in my March 31 post I laid out what it depends on: things such as guidance for the second quarter, the trend in oil prices, the likelihood that stocks will jump the very low hurdle set by a forecast of a 7.4% drop in earnings from the first quarter of 2015, etc.
But I am very sure that a quarter like the one we’re about to see reported is going to contain lots and lots of volatility at the level of individual stocks. Even if the indexes as a whole don’t go anywhere–or perversely go up on less bad than forecast bad news–I’m sure that traders and investors will see lots of stocks soar (well, I’m sure some will) and crash (much more likely) because in an environment clouded with worry the market will treat any failure to beat already inflated expectations as a cause for major punishment.
And its those stocks that get punished big time for relatively minor failings–especially if the failing is little more than not living up to inflated expectations–that I’m interested in this earnings season. I’d love to snap up a growth stock with solid long-term growth potential if it gets knocked down 10% or 20% or 30% because revenue growth of 50% missed expectations for 65% growth.
Let me make it clear what I’m not looking for at this point. I’m not looking for growth stocks that have suddenly become much cheaper because their once solid growth stories have become less solid.
I’m not looking for stocks that will recover–and show big gains–if a predicted trend (the recovery of oil prices to $65 a barrel, for example) plays out. (Time for that down the road when we have some evidence that the trend is turning.)
What I’m looking for is stocks that have been punished excessively because they missed expectations in some essentially meaningless fashion.
I’ll be looking for those among the high multiple stocks that always get punished most heavily when they miss. Stocks that are trading with PEs of 35 or 45 or 55 or 65 or … always see a stampede to the exits when the market is worried in general and when it looks like the numbers signify something important at first glance. As a group, these are probably stocks that you’ve considered buying because you like their growth trajectories in a market where growth is hard to find, but that you’ve held off buying because they were just so expensive (on a PE basis) and therefore just so risky. Now is a quarter when we might be able to pick up a few of those.
You’ve probably got your own list. Stocks I’m looking at include but aren’t limited to Palo Alto Networks (PANW), Mobileye (MBLY), Facebook (FB), Netflix (NFLX), Amazon (AMZN), Nvidia (NVDA), Costco (COST), and CVS (CVS)
You can’t buy if you don’t have any cash so I’m going to sell a few positions in my Jubak Picks portfolio to make some room for bargains–if any should come my way.
Yesterday I posted that Monsanto’s (MON) ugly earnings report provided important guidance for navigating earnings season. Wall Street analysts are projecting a 6.9% drop in third quarter earnings but that decline won’t be spread evenly across all market sectors. Energy stocks will, of course, see a big drop in earnings but, according to Standard & Poor’s, sectors such as telecommunications, technology, consumer discretionary, and health care will see growth of 10% or better.
Now we get a further bit of navigational advice from Yum! Brands (YUM). On Tuesday, after the market close, Yum! Brands reported earnings of $1 a share, 7 cents lower than Wall Street estimates, and revenue of $3.43 billion instead of the projected $3.67 billion.
But what is important for navigating this quarter’s earnings season was the market reaction to this miss.
Companies miss earnings projections by 7 cents or about 6.5% all the time. It’s never good news.
But seldom do stocks get taken out and shot for a 6.5% miss.
And that’d exactly what the market did to Yum! Brands. The shares closed at $83.42 on Tuesday before the earnings report and then plunged Wednesday after the open to $68.09 as of 10 a.m. New York time. That’s a drop of 18.5%.
Now there’s no doubt that Yum! Brands disappointed pretty much across the board. Same store sales in China, which accounts for about one-third of Yum’s operating profit, grew by just 2% instead of the projected 9%.
But Yum! Brands real offense was disappointing the market in some of the places where the market is most susceptible to fear.
Financial markets are worried about slowing growth in China? Yum’s results raised the possibility that growth in China had slowed so much that the company’s revenue would never completely bounce back from the food-safety scandals that had devastated sales. With growth in China slowing, what if Yum’s food safety scandals had destroyed the brand with Chinese consumers? Forever!
The other fear that hit Yum like a cold burger patty in the face was worry that growth in the fast food sector was over Forever! McDonald’s (MCD) revenue line has been essentially flat for four years. The sector is battling perceptions that its customers have moved on to better quality food and are looking for something other than gray burgers and overly salty chicken. What if the sector is never coming back?
Never is a long time and it’s a good bet that the fears about the future of Yum sales in China and about the death of the fast food sector are somewhat overblown. That’s what happens in a panic.
But the larger point for investors during this earnings season is that the markets are littered with land mines that are just ready to blow up on any company that steps on one. China growth slowdown is obviously one such land mine and Yum! Brands won’t be the last company to trip that mine this quarter. Falling commodity prices make up another mine—I’d look out, especially, for oil, copper and iron ore. The strong dollar is a third—look for exporters that live up to fears that a strong dollar will decimate sales. I’m sure there are others—falling prices in the drug sector as a result of political and regulatory scrutiny, for example. I’m sure you can make up your own list of land mines and the companies most likely to step on them.
So far in absolute numbers this earnings season could be called somewhat disappointing. About 50% of the 10% of Standard & Poor’s 500 companies that have reported earnings have beaten Wall Street estimates. That’s below the long-term average of 63% and well below the four-year average of 74%.
But I think the earnings season so far is actually more disappointing than that absolute underperformance suggests. Too many of the earnings beats are by just a penny or so and too many earnings surprising are coupled with misses on revenue. Others combine an earnings beat with a cut to guidance for the first quarter or all of 2014. And other companies are managing to report an earnings beat only thanks to a clearly one-time factor or a bit of financial engineering using, frequently, share buybacks.
With U.S. stocks ending 2013 at historical highs, investors just aren’t impressed with that kind of earnings beat.
Want some examples?
Johnson & Johnson (JNJ) reported earnings per share 4 cents above the analyst consensus. But the company forecast that 2014 earnings would be $5.75 to $5.85 a share. That’s below the Wall Street consensus estimate of $5.86 a share.
Abbott Laboratories (ABT), a Jubak’s Pick portfolio member http://jubakpicks.com/the-jubak-picks/, reported earnings per share in line with estimates but revenue climbed just 0.4% and missed analyst estimates by $64 million.
US Bancorp (USB) managed to beat on earnings by a penny a share but revenue fell by 4.4% year over year and was just in line with estimates.
McDonald’s (MCD) beat on earnings by a penny, but revenue grew year over year by just 2% and came in $15 million short of Wall Street projections.
Verizon (VZ) beat analyst estimates by 4 cents a share but reported revenue $29 million below expectations.
Of course, this earnings season is also reporting the usual share of just plain bad results such as the 5 cents a share earnings and the $66 million revenue miss at Coach (COH.)
But truly positive reports, like the 11 cents a share earnings surprise at ASML Holding (ASML) with revenue growth of 81% year over year that put revenue $22 million above Wall Street estimates, have been light on the ground so far this quarter.
Which has put investors in such a funk about earnings and revenue—and the prospects of future earnings and revenue—that even an ASML falls on its news.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of December. For a full list of the stocks in the fund, see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.
It wasn’t much of a hurdle, but it looks like companies jumped it in the third quarter.
With 90% of the Standard & Poor’s 500 reporting, earnings are up 3.7% year over year for the quarter, according to FactSet. Taking into account estimated earnings at companies that haven’t yet reported, earnings are projected to show 3.5% growth in the quarter.
Going into the third quarter, companies were projected by Wall Street analysts to show 1% earnings growth. Among companies that have reported, 69% have exceeded consensus earnings estimates. That’s at the high end of the average historical range. Earnings grew by 2.6% year over year in the second quarter
Third quarter revenues are up 2.9% with 52% of companies beating analyst projections on revenue. Sales grew 1.7% year over year in the second quarter.
The end of the third quarter shifts attention to projections for the fourth quarter. Estimates now call for fourth quarter earnings growth of 7% on sales growth of 0.6%. Estimates almost always come down as earnings reporting season gets closer so I’d expect fourth quarter estimates to decline as we move through January and February and into March. Three months ago projections for the fourth quarter called for 10% earnings growth.
Projections now see earnings growth of 5% for the full 2013 year on 1.9% sales growth. If those projections were accurate 2013 would turn out to be slightly better than the 4% earnings growth in 2012.
Projections for 2014 are now looking at 11% earnings growth and 4.3% revenue growth.
If 2014 earnings come in on those projections, the S&P 500 trades at 14.8 times 2014 earnings.
The likelihood of 2014 projections being too optimistic, however, is extremely high.