The Forward Earnings Outlook with Brian Gilmartin

Brian Gilmartin, CFA, is the founder and portfolio manager at Trinity Asset Management, Inc. Brian’s been managing money for high net worth individuals, and foundations since 1995. Trinity uses a bottom-up, top-down approach for client portfolios.

Per ThomsonReuters, “This Week in Earnings”, the forward 4-quarter earnings estimate for the SP 500 fell $0.15 last week to $115.71. from the prior weeks $115.86.

Despite the continued worries by the financial media over “retail earnings” (and for whatever reason, a lot of retailers did not have good July ’13 quarters) the SP 500 forward earnings estimate fell just $0.25 from Friday, August 2nd, through Friday, August 30th, and most of that came in the last week.

The p.e ratio on the forward estimate is 14.11(x). (Per Factset, the SP 500 is slightly above the 5-year average p.e and slightly below the 10-year average p.e.)

The current “earnings yield” on the SP 500 is 7.09%.

The growth rate on the forward estimate slipped a little this week to 7.12% from last week’s 7.28%, but still remains at its highest level since the first quarter of 2012. More importantly, the forward growth rate is heading in the right direction, i.e. upward sloping.

With 490 of the SP 500 companies having reported their Q2 ’13 results, SP 500 earnings grew 4.7% up from the 2.6% estimate on July 1, ’13 (and a little short of where we thought the final number would be, i.e. above 6%), while revenues grew 2.2%.

A Look at Sectors:

Financials: If you look at the earnings data, both historical and projected, Financial sector earnings make a compelling case for remaining overweight the group through (at least) the 4th quarter, 2013. Currently, the 2014 estimates for Financials are looking for much slower growth than what we’ve seen in 2013, and it was around this time that last year (late summer, 2012) where we started writing about the positive tone for Financial sector earnings.

What is the primary reason for the strong earnings growth for the Financial sector in 2013 ? Well, if you read the 2nd quarter, 2013 FDIC earnings report released to the public this week, you have record nominal profits for the banking sector for the 2nd quarter in a row. However I dont think a lot of people understand this concept since so many bank stocks are still trading below their 2007 highs, thanks to the dilution of the equity shareholder following the financial crisis. The number of fully-diluted shares outstanding for names like Morgan Stanley (MS), Bank of America (BAC), AIG (AIG) and others is sometimes quintuple their share count since mid, 2007. (long BAC). Banks and financials are earnings record profits, but “per share” earnings have been horribly diluted.

The real key to the FDIC report was the record low in non-performing loans (NPL’s) , which has led to reserve releases across the sector. Per the FDIC report, NPL’s improved for the 13th consecutive month, led by single-family housing. In addition the amount set aside by banks for NPL’s fell 40% year-over-year to $8.6 billion or the lowest since the 3rd quarter of 2006.

For the 2nd quarter, 2013, Financial sector earnings rose 30% year-over-year, up from an expectation of 17.5% on July 1, ’13, on just 6.2% revenue growth. While some of this huge upside surprise capital-market driven by GS and JPM, etc. I do think a lot of this is the loan-loss provision, and much better credit.

The point is that “credit improvement” is still driving sector earnings, even though we expect this game to be played out by 2014, or at least greatly diminished.

Unfortunately, Dodd-Frank will likely squash the kind of revenue growth we saw in Financials in the late 1990′s, and through 2003 – 2006, in coming years. Revenue growth for the sector off the March ’09 market low, have been relatively subdued between 2% – 5% for the most part, and I dont think – absent a change in Washington – that will change much going forward.

We think JP Morgan (JPM), Goldman Sachs (GS), CME (CME), Schwab (SCHW), Bank of America (BAC) and Wells Fargo (WFC) offer excellent value (for different reasons) through the end of 2013, and into early 2014.

For Q4 ’13, the current estimate is that the Financial sector will grow earnings 26.4%, which is an estimate that has changed very little since Jan 1 ’13. Given that the SP 500 is expected to grow earnings just 11% in Q4 ’13, readers get relative earnings growth potential coupled with reasonable valuations, and good dividends.

Tough combo to beat. Stay with Financials. The stocks have pulled back nicely since the August 2nd peak in the SP 500 of 1,709, but there is little technical damage.

Our game plan is to remain overweight Financials and re-think our weighting after Jan 1 ’14.

Consumer Staples:

Consumer Staples as a sector is now the most oversold of all the SP 500 sectors, given Bespoke data.

Just 15% of the sector is trading above their 50-day moving average.

We are preparing an article on the sector now, to be published this weekend.

Our three primary positions are Wal-Mart (WMT), Coca-Cola (KO) and Procter & Gamble (PG) and all are oversold on the daily charts.

Some Fast Facts on the Consumer Staples Sector:

  • 10% of the SP 500 by market cap;
  • Q2 ’13 earnings growth for the sector was 3.6% as of 8/30, versus the 3% expected on July 1;
  • Q2 ’13 revenue growth for Staples was 1.5%, with a downside surprise of 1% thanks to currency (strong dollar);
  • The last 6 quarters, Staples have grown quarterly earnings between 3% and 10%, with most of the variability due to the forex volatility;
  • For Q3 and Q4 ’13, sector earnings expectations are for 5.3% and 7.3% growth respectively;
  • The primary reason that we are looking at the sector, more for a 2014 play, is that with the Bespoke data study that shows “Domestic vs. International” performance, International companies (those SP 500 components who have 50% of the company’s revenues from Non-US countries) are narrowing the performance gap significantly, in 2013, and with Consumer Staples, you get a big chunk of revenues from Non-US sources.

Final thoughts on Q3 ’13 and Q4 ’13 earnings:

Here is the table on the revisions for Q3 ’13 earnings by sector since July 1. (The first column is Q3 ’13 earnings expectations as of Friday, August 30th, and the 2nd column is as of July 1.)

Q3 ’13 earnings estimates:

Cons Disc: +7.4% and +12.6%

Cons Spls: +5.3% and +9.0%

Energy: -0.3% and +3.8%

Financials: +11.3% and +12.5%

Hlth Care: +3.4% and +5.1%

Indus: +4.6% and +7.7%

Basic Mat: +0.9% and +16.2%

Technology: +3.1% and +7.4%

Telecom: +8.8% and +17.3%

Utilities: +1% and +2.1%

SP 500: +5% and +8.5%

If we exclude Telco (which, as a sector, is only 6 companies), only 3 sectors (Financials, Discretionary and Staples) are expected to show stronger relative earnings growth than the SP 500 in q3 ’13.

Q4 ’13 Earnings:

Cons Disc: +14.1% and +16.6%

Cons Spls: +7.3% and +9.2%

Energy: -1.9% and -0.5%

Financials: +26.4% and +25.1%

Hlthcare: +8.4% and +10.1%

Indus: +16.8% and +18.5%

Basic Mat: +13.8% and +23%

Tech: +7.8% and +10%

Telco: +20.3% and +47.8%

Utes: -4.3% and -2.4%

SP 500: +11.2% and +13%

Again, if we exclude Telco, and assuming no change in growth (which there undoubtedly will be), the 4 sectors are expected to shown stronger relative earnings growth in q4 ’13 are Financials, Discretionary, Industrials and Basic Mat.

Conclusion: without beating the reader over the head, the case for Financials is compelling here, (at least through year-end ’13) with just 20% of the stocks trading above their 50-day moving average (per Bespoke) and the sector oversold on the charts. We are watching Staples, Industrials, and Basic Materials for a “return to global growth” theme. Europe is improving, and so is Japan.

The landscape changes rapidly on the earnings front. All it takes is one company with a big upside or downside surprise, and the whole sector gets revised.

I don’t think we are in that environment. Earnings expectations are subdued, and management’s along with analysts have no reason to be aggressive. Forward earnings estimates for the SP 500 have bounced back to the 7% growth range, which is the long-run post WW II average growth rate.


Brian Gilmartin, CFA, is the founder and portfolio manager at Trinity Asset Management, Inc. Brian’s been managing money for high net worth individuals, and foundations since 1995. Trinity uses a bottom-up, top-down approach for client portfolios.


Follow Brian on Twitter @TrinityAssetMan

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