The litmus test for stocks begins

[The-Shoveler]

Nor_LA-Temcu-SD-Guy

Another good Qoute I saw in a cartoon,

From a fortune cookie, “Your stock picks are no good”, But they were recomended by that screaming lunatic on CNBC how can they be no good !!!

[Wiley]

If there is so much excess liquidity (which I totally agree) then you’ve got inflation. Me thinks it will show up in cost of goods thereby affecting earnings negatively.

[poorgradstudent]

cabinboy wrote:
“My prediction: The U.S. stock market will continue to do well over the next two quarters, unless interest rates are raised unexpectedly.”

That’s my general feeling too, although it’s a hunch as much as anything else. I’m a pretty big fan of Morningstar, who still feels the market is pretty undervalued.

I do expect a shift from growth towards value and from small to big as fears of slowdown/inflation continue sinking in. I’d point to the skyrocketing price of Coke and the Dow’s general outpacing of the other indices as pieces of evidence for that. Again, just guessing, but in the short run my guesses have been fairly good lately.

[qcomer]

Wiley,

It’s a very good point. Since 2000 there has been a flood in liquidity that has resulted in boosting home prices, commodity prices, etc. However, the reason this hasn’t made CPI blow through the roof is because of the cheap products that we get from China. The flip side of these cheap products is the higher trade deficit and hence the downward push on dollar or cash savers. However, the same money generated by japanese/chinese exports is re-invested into US equity, US treasuries and the circle continues. However, this imbalance cannot continue forever. I think the ultimate loser is going to be dollar (it already is and has lost 35% against euro).

But despite worries of economists about these imbalances since the beginning of 2004, stock market in general has done well and folks who have sat on their hands have lost great investment opportunities in the US and abroad. I don’t see these imbalances causing global markets in a week. Until, I start to see real signs of economic recession and the market reaction to that, I believe we should stay with the rally (especially with corporates reporting 15% earnings growth).

[qcomer]

Excerpt from thestreet.com about excellent corporate earnings this quarter.

“With about 278 companies in the S&P 500 reporting, 76% have beat expectations, 12% have matched, and 13% have fallen short vs. the typical breakdown of 60/20/20, according to John Butters, analyst at Thomson Financial. If the season ends with 76% of company reports beating expectations, the third quarter would mark the highest number of blowouts in 10 years, he says. The oohs and ahhs don’t end here. Companies are beating expectations by 6.1%, much more than the historical average of 3.2%, says Butters. In recent quarters, companies have beat by about 5%. In all, earnings have grown 17% in the third quarter, much more than the 14% estimate before the reporting began, says Butters.”

To me this again dispels the notion that this rally was not broad based and only few companies benefited from it. Tomorrow if the GDP number comes out ok, then this rally will probably carry on for another quarter.

[powayseller]

Don Harrold’s video (thanks for the link) shows that only 1 out of 4 Dow stocks are above their 2000 prices, and the other 75% are actually in the red compared to 2000. Companies have been buying back stock and doing mergers, so what is the true earnings from operations? There is a lot of fudging with the expectations numbers too, as Fleck explains: companies will give lower guidance a few weeks before their earnings report comes out, and then provide the miraculous “beat-the-number”. This is engineered earnings. If you look at the expectations set at the last meeting, then how does it compare??

The most important indicator of the corporate health is the increase in profits from operations versus last year? That strips away earnings expectation manipulation, stock buybacks, and mergers. Let’s also take away options games.
Maybe you can explain this part, since you are following the stock market so closely. I am curious what is the true health of the companies, not just the spin they can get away with on managing expectations.

[heavyd]

Did anyone else do a double-take when they read in qcomer’s post that 80% of reporting companies “usually” beat or at least meet expectations?

I’m not saying it’s wrong, and I’m not saying that many US companies have been reporting decent numbers the past 2-3 weeks…

But think about it…how is it that corporates keep “surprising on the upside” much more than half of the time?

Worth thinking about…

[heavyd]

To answer my own question, here’s how stocks can consistently “surprise on the upside”:

Proctor & Gamble, PS US, is a Dow Industrials component.

According to I/B/E/S, there are 17 analysts on Wall Street who actively cover the name.

For the September 2006 quarter (to be reported next week, on 10/31), the range of estimates is 76 to 79 cents per share, with consensus at 77.9 cents.

Even for a consumer products company, that’s a pretty narrow range, don’t you think?

And management’s own guidance? Between 76 and 78 cents — so The Street is expecting a result above the mid-point of management’s guidance. Pretty aggressive!

PG will do about $18bn in revenue in Q3, and maybe $2.8bn in net profit. Between the top line and the bottom line PG management has about seven jillion ways to manipulate reported earnings.

So…I am betting that PG, like a lot of listed companies, will beat earnings next week.

Buy some PG!!

[qcomer]

Heavyd I didn’t say that 80% companies usually beat estimates. The 76% number is only for this quarter and historically, 60% beat estimates, 20% meet and 20% miss. I am in hurry and will post reply to PS question later.

[heavyd]

Re-read my first post, I quoted you saying 60% usually beat and 20% meet — that’s 80% beating or meeting, right?

[poorgradstudent]

Companies generally do give pretty conservative guidance to help them beat expectations.

Still, the numbers have been very solid this earning’s season. I know a number of big companies posted big increases from last year. Of course, not every stock that beats expectations goes up. Mostly I’ve noticed the biggest jumps are caused by analysts upgrading or downgrading stocks. This can result in hilarious jumps of 5, 10, even 20% in a day. “Wait, the company that was worth 20 milliion yesterday is only worth 16 million today? But… nothing changed?”

The market almost always overreacts to both good and bad news, then gradually corrects.

There probably will be a lot of uncertainty following the election, regardless of who wins. If you’re looking for a good point to take some profits, the Monday before election day might be a good day to trim some positions for safety.

[qcomer]

Poway,
Here are few things you raised.

1. You are correct that the true indciator is YOY earnings growth and YOY earnings growth has been 17% for this quarter when the expected was average of 14% YOY growth. These are just solid solid earning numbers. More than that companies are sitting on piles of cash and they can pump that liquidity in to do stock buybacks/mergers etc.

2. I am not comparing DOw component or SP500 company prices as compared to 2000 values. I can say in the same way to compare to bottom values in 2001 and look at the amazing returns. But I am talking about the current July rally and earnings as well as gains by most SP500 companies, indciate this rally has been broad based.

3. Companies do stock buybacks from the profits that they have earned and if stock buybacks are announced by a company then analysts account that in their estimates. More than trying to push EPS aove estimates, the main reason for buybacks by big corporates is investing in itself when company considers the price is right (takes care of stock option grants to employees, etc). Now, same goes for mergers and are mainly done to buy a competitor or a company doing poorly that can be rejuvenated. Options are included as expenses in earnings as one time expenses in most companies and hence are accounted for in the EPS number. Investors look at the cash flow that a company generates and the capital that it is sitting on and hence potential for buybacks/mergers. The balance sheet, cash flow, etc is normally all priced in the share value.

4. Companies do give conservative forward guidance which is the natural thing to do. However, markets are such tough tough crowd that you can get hammered for beating estimates but not giving a forward guidance that investors expected. In addition, if you invested in growth company that gave a conservative forward guidance, the company can get hammered for slowing growth fears. Also investors (especially institutional investors) know all these little tricks of companies. Whole concept of beating estimates is that current sharevalue represents company’s growth prospects, cash flow, balance sheet, etc and are hence already priced in. Any +ve surprise is then priced positively in share value and vice versa.

[poorgradstudent]

Great post qcomer. Only one thing I’d add:

“Companies do stock buybacks from the profits that they have earned and if stock buybacks are announced by a company then analysts account that in their estimates. More than trying to push EPS aove estimates, the main reason for buybacks by big corporates is investing in itself when company considers the price is right”

This is true. However, buybacks also can be viewed as a sign the company doesn’t see any worthwhile growth prospects for its cash. This is pretty common with extremely large companies. Still, buybacks are often a good sign, because minimally it says the company thinks its shares are worth as much or more than the market does.

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