ARE EARNINGS ESTIMATES TOO HIGH?

ARE EARNINGS ESTIMATES TOO HIGH?

Courtesy of The Pragmatic Capitalist

This excellent piece (below) was on Bloomberg yesterday and cites another bearish note from Gluskin Sheff’s David Rosenberg.  It notes that the analyst community now expects 35% earnings growth for 2010.  They go on to show that this has only happened 6 times in 75 years and has been accompanied by 10% GDP growth each time.  In essence, the implication is that this recovery is entirely different and is unlikely to rhyme with these other robust earnings recoveries.  This is accurate, but terribly misleading in terms of timing.  Have a look here and continue reading below:

What Rosenberg and Bloomberg fail to be more descriptive about is the timing of these high estimates.  As we have long noted with our expectation ratio and earnings analysis (which has been spot on) the analysts have remained far too bearish for the last year. Where the above analysis goes wrong is in bunching 2010 estimates together as a whole as opposed to breaking them down by quarter.

A closer look at these estimates is vitally important in positioning your portfolio for the coming few quarters. In our 2010 investment outlook we said we were bearish about H2 2010 partly due to the potential for overly optimistic earnings analysis. If you look at current estimates analysts are calling for just 2.7% sequential growth in 2009 Q4 earnings. For 2010 Q1 they are calling for just 1.9% sequential growth.  In a nutshell, they expect earnings to be in-line with the last few quarters (which I believe is utterly naive and lacking in any real analysis worthy of paid employment).   These estimates are almost certainly low.  Where things get interesting is in the later quarters of 2010.

In Q2 analysts are calling for a big jump in growth to 11.3% sequentially and 33% year over year. The same goes for Q3 where they are currently calling for 7% sequential growth and 25% year over year growth. These are big numbers. $19.72 & $20.62 in operating earnings per quarter is essentially what the S&P was doing back in 2006 & 2007 when the economy was at record low unemployment and the banks were cranking their high leveraged ponzi scheme on all cylinders. Can we realistically return to such levels so quickly? Call me a skeptic.

But timing is vital as I said above. In essence, the big estimate jump is backloaded in H2 and won’t become a major hurdle for corporations until this summer. Until then, the Expectation Ratio is dead on and continues to forecast an environment where analysts are far too pessimistic and stocks will likely drift higher as investors play catch-up. What will make these H2 estimates particularly interesting is their timing with potential rate hikes and the end of the government stimulus. The end of 2010 and beginning of 2011 has serious potential for downside surprise. Until then, I expect this market to frustrate and obliterate those who stubbornly short it.

Stay tuned early next week for our outlook on Q4 earnings reports.