A Slightly Different Take On The Recent 'Good News'

Companies in the S&P 500 had been beating earnings estimates at a higher rate than in a typical quarter, providing ammunition for those who believe that bottom-line growth is what has been driving share prices higher. But a post at Thomson Reuters' Alpha Now blog gives us a slightly different take on the recent "good news."

These second-quarter reports may not be as rosy as these figures make them seem, however. That’s because underneath the headline-grabbing growth in profitability, it’s clear that companies aren’t doing nearly as good a job when it comes to beating analysts’ expectations on the revenue front. Last week’s crop of second-quarter earnings reports from industrial companies – one of the strongest sectors in the market, of late – reinforced that trend, with ten of the 12 S&P 500 Industrials companies that announced results last week posting better-than-expected earnings but only three saying that their revenue came in ahead of expectations....

...At the beginning of earnings season, analysts were predicting that industrials companies – as a group – would generate 6.4% growth in revenues, putting them third among the ten sectors in the index. So far, however, only 26% of industrials companies have announced revenues that were higher than analysts’ forecasts, and that revenue growth rate was only 5.5% as of the end of last week. To produce higher earnings on lower-than-anticipated revenues requires companies to boost their margins, and indeed, industrials in the S&P 500 have seen their net margin climb from 8.6% to 9%.

That may have been OK up until now, but amid clear evidence that the global economy is slowing down, notes blogger Greg Harrison, the top line that may soon matter more.

To the extent that companies aren’t able to support earnings growth via higher revenues, companies will have to rely increasingly on boosting efficiency or cutting costs – or run the risk of disappointing investors on the earnings front as well as on revenues in the future. The trend taking shape in corporate revenues serves as a reminder of a growing source of risk to corporate earnings as 2012 moves forward.

Of course, if all you care about is which rabbit Uncle Ben is going to pull out of his hat at the next Fed meeting (or whenever he feels like it), then please ignore the foregoing and carry on as before.