bizzXceleration: Performance, Value and Profit

Fascinatingly the markets are up today, led by Financials of all things. Will wonders and delusions never cease ? This despite the fact that, other than WMT earnings, all the economic news was unremittingly bad: foreclosures are up 55%, new house prices dropped -7.3%, continuing jobless claims accelerated and new claims were unexpectedly high and consumer inflation jumped 0.8% MtM, a 17-year high ! None of that sounds like the outlook is sanguine in the sense of good. Anyway, as threatened, we're going to revisit the outlook and consequences for corporate earnings and what it means for the market. Tracking which posts get the most attention, equally strangely if not more so, the diagnosis of a schizoid market attracted more attention then the careful dissection of the profits outlook (Talkin Profits: Economic Outlook, Earnings, Business Performance ?) and what the rapidly deteriorating economic outlook means. To put a point on it if we are indeed crossing a tipping point and starting into a consumer-driven downturn, as is now being widely recognized, ignoring profits and the current market valuations is dangerous to your financial health. On the grounds that perhaps we haven't made it entirely clear why you really care we're going to build a longish post walking thru various aspects of profits, earnings, PE's and the outlook. Just as one example most of the downturn so far in the S&P is due to Financials. If the economy turns over, as we expect, none of that is priced in.

Economy vs Markets

Just to set the stage let's start by considering the long-run relationship between the economy and the Markets. The meme is that markets are forward-looking though the WSJ noted that hasn't been true recently - as in the last decade ! Actually it's never been true. This multi-part chart shows the YoY% changes in GDP and the SP500 on top and the % growth in both since 1951. To our eyes the markets are still far ahead of where the state of the economy would justify their current levels.

Earnings Outlooks

Hopefully the prior post put enough evidence on the table about the structural relationships between the economy and profits that we can take it as given. And the translation between Profits and Earnings will also be taken as understood. That being the case the fundamental valuation equation we like is Graham-Dodd's: PE = (8.5 + 2*Growth)* 4.4/AAA-Yield. We'll dig into that a little later but taking it as a starting point the question becomes what are earnings expectations. And, much more importantly, do they make sense in view of our economic outlook. Take a look at the following chart which reproduces S&P's bottoms-up collection of analysts earnings prognostications and take a careful look at a) the revisions by sector and b) whether or not you believe the outlooks. And to put another point on it the two sectors that are up today and driving the market are Financials and Consumer Discretionary - with the big debate about a bottom in Financials raging onward (Riding the Storm - NOT: Breakdowns, Culture & Malfeasance in Finance).

 Now if you're readers of this blog and these two sets of earnings estimates hang together for you you can probably stop reading. But if thinking that the Financials (in read) and the Discretionary and Technology outlooks (in yellow) have some questions that should be asked below we walk thru some valuable issues of PE and valuation that should be reflected. And aren't IOHO.

Continue reading "Profits, Earnings, PEs and Outlooks: Why You Should Reall....lly Care" »

Posted by dblwyo at 10:54 AM | Permalink | Comments (0)

The bridge between the economy and company performance is the markets, going both ways. But the keystone of the bridge, that holds everything together and which the rest of the linkages depend on, is earnings. As of right now we think that keystone is crumbling under the growing credit and economic pressures. We also think that the analyst community is somewhere between optimistic, wildly optimistic and perhaps on drugs. The question is do we drink the koolaid along with them. And we're definitely not alone in those views. Before going on may we suggest spending the ~3 min. on the accompanying video from the FT and their very astute financial reporter John Authers (btw his regular daily vidclips appears to us to be extremely valuable and worth checking on). If you click thru you'll be taken to the vidclip on the earnings outlook but you can see the gist of the argument in the chart. With Financials included analysts as a whole are looking for a 60% jump in late '08 and excluding financials are looking for low double-digit growth thru '09 ! Which we think completely misundertands what's going on with the economy and where we're at in the business cycle. And is also very unrealistic in the face of an accelerating slowdown, tighening credit and rising worldwide inflation. To help you make your own judgements we've collected a large batch of readings and links in the readon section, in three parts. First is a collection of overview stories followed by a collection of our own posts analyzing the deeper structural characteristics of earnings followed by a week-to-date collection of earnings reports.

Continue reading "Readings (Earnings): The Real Earnings Realities that Ain't...YET" »

Posted by dblwyo at 12:28 PM | Permalink | Comments (0)

We left a takehome test with y'all in yesterday's post on Bigg's Bottom vs the News. The key question being was his argument (and all the fairly sensible folk on CNBC) aligned with a whole slew of major scary news - that picked up four of our major themes btw. So what was your answer ?

We're going to sneak up on ours though our direction is pretty clear but before taking a look at some charts and graphs (follow-on post) we'd like to ask what's driving the Street's optimisms. The answer turns out to be very clear - the Street and the analyst community is expecting a major uptick in earnings growth (something else we've been ranting on about as well) but we thought we'd do a compare & contrast between Fortune (who's reporting what it's been told) and Jim Jubak (who's analyzing what he sees).The differences are large, understandable in view of their different responsiblities and the gap tells us what's driving the market sentiment right now. If you check out Fortune's chart from Thompson the rationale is pretty clear. In fact if we thought those were the numbers then now would be a good time to reverse direction from our current position. Here's what Fortune had to say:

Continue reading "Grading the Takehome: Bottoms, Earnings & Outlooks" »

Posted by dblwyo at 08:43 AM | Permalink | Comments (0)

Well after puzzling some more on the outlook for the economy, profits, earnings and EPS I may have stumbled across an explanation for why the prognosticators have such a sanguine view of things. Just to review, the economy is slowing and faces more and more headwinds. In fact recent polls show a majority expect a recession in '08 and feel that we may be in one now.

• Americans Turn Negative on Economy, Expect Recession, Poll Says
• 2/3rds Americans Say Recession is Likely 
  

In digging into earnings we found that EPS growth is not organic in the sense that it's based on growth in revenue, profits or earnings. And we found that to be consistent across three, no four, different and major data sources: GDP accounts, National Income accounts, WSJ reported earnings/profits by industry and S&P reported EPS by industry most recently. As they say - it's a puzzlement.

BUT...but...but if you look at the accompanying table it starts to become clearer. EPS growth rates by sector from the most recent S&P numbers. Take a look and see what you think. EPS growth as reported actuals and estimates from Q106-Q407, based on YOY% growth, lines up with the other data. When you add the '08 numbers the averages show some uplift but not big jumps. In other words it's the going forward expectations for Q108-Q408 that make you shake your head.

For the SP1500 overall EPS growth in '06 & '07 averaged 10.6% and is estimated to grow to 11.7%, which results in the 13.8% estimate for '08 as a whole. The sectors projected to perform exceptionally well are Technology, Telecom and Consumer Discretionary. Only Energy and Materials are estimated to have rates less than 10% and all the other sectors are projected to do well, with growth of EPS in the 10-14% range.

Continue reading "Review the Bidding, Count the Cards: EPS Growth Rates" »

Posted by dblwyo at 08:42 AM | Permalink | Comments (0)

Seeing the elephant is an old phrase borrowed, I think, from the British Army and used by many armies now and refers to one's first experience of something new and shocking. In their case combat - which is about as shocking as it gets. Fortunately our experiences aren't going to be on anything like that level. But still the Elephant here is learning that for the first time the old linkage between GDP, Profits and organic economic growth appears to be frayed to the breaking point (Dr. Pangloss Treating Goldie: Markets, Profits & Earnings, The Heart of the Matter: Profits vs Earnings ? ).

But first a small confession. My early religious training was in economics and after spending several years as a novice and then a few more in monastic retreat (otherwise known as grad skul) I went apostate and joined the real world. Now economics would tell us that any industry or product that gets a large return/profit must be serving someone somewhere. Yet as the share of Financial companies in profit has gone from 10% to 20% to, in just the last few years, 30% I begin to find myself turning into a modern Physiocrat. They were some of the earliest formal economists and started with the argument, in late 18th C France, that the only true source of wealth was Agriculture. Given the structure of the economy at the time they had a point if not a case. But other sectors like trade, manufacturing and finance were important contributors who's outputs made the functioning of the agricultural sector more efficient - thereby raising overall output and producitivity. Nonetheless I still find it difficult to believe that Finance contributes so much to the effective functioning of the economy that a 30% share of returns is warranted. Oh well...

Back to the Elephant and this time we'll go to the central cathedral of capitalism the Wall St. Journal - specifically it's recent reporting on quarterly profits and earnings. Which, BTW, they report as net operating income, NOT EPS ! 

Continue reading "Have You Seen the Elephant ?: More on Earnings" »

Posted by dblwyo at 08:53 PM | Permalink | Comments (0)

If you look back over the last two Weekly Readers they both might be said to converge on key question - where will earnings go ? Or broken down a little more will businesses continue to generate profits and will those turn into reasonable earnings ? And earnings growth in particular ? Earlier (Dr. Pangloss Treating Goldie: Markets, Profits & Earnings) we'd taken a pretty hard look at that question and found that Profits were strongly correlated with GDP growth and Earnings (ala S&P reported earnings/EPS) were strongly correlated with Profits. It might be worth your time to re-vist those charts and arguments because they lay a foundation for this discussion.

But we're presented with yet another conundrum - if the economy has been slowing why have earnings been growing ? As a partial answer let me quote from the earlier posting:

We can only conclude that with the lid screwed down on spending companies are making plenty of money, grabbing a growing share of the economy and, one guestimates, spending it on buybacks to keep the stock prices up and help out with EPS numbers. Which doesn't lead one to a great deal of confidence in organic growth of revenue, profits and earnings.

Stop and think about that for a minute - earnings may be going up but it's not because the economy or business is doing better. Somewhere under all the large pile of stock prices and reported earnings is a very large elephant. And he wouldn't appear to be a very well-groomed, well-behaved or benign one either.

We're definitely not in Kansas any more - so much for fundamentals. It's all about the finances and cash flow ?

 If you believe that argument, or at least think it raises some serious questions, then we thought it'd be worth looking into some more. Basically when we say growth is not organic what we're arguing is that EPS growth is NOT the result of growth in revenue or profits - rather it results more from throwing cash flow and borrowings at buybacks while screwing down the lid on expenses, hiring and capex spending.

Having set the table let's take a look at what some National Income accounts can tell us about the shares of profit from various sources. An idea we stole from Paul Kasriel and the Northern Trust economics team in their last US Economic Outlook (which we highly recommend reading for this and other reasons). 

So let's go elephant hunting. 

Continue reading "The Heart of the Matter: Profits vs Earnings ?" »

Posted by dblwyo at 01:39 PM | Permalink | Comments (0)