Last quarter, profits wowed Wall Street. Can Corporate America beat investors' higher expectations this quarter?
It wasn't exactly a barn-burner. Wall Street's summer earnings season started Monday when Alcoa (AA) released its second-quarter numbers. The giant aluminum company's earnings of 81¢ per share were 1¢ lower than analysts were expecting, according to Reuters. Profits were down 4% from a year ago, and revenues of $8.1 billion, though a record, fell short of consensus estimates by $300 million. Shares fell 1.65% in aftermarket trading.
"We have achieved another strong quarter," said Alain Belda, Alcoa's chairman and chief executive, in a statement.
Upcoming: Boost or Correction?
Like the Iowa caucuses in Presidential politics, Alcoa traditionally goes first in what, four times a year, is a crucial test of the stock market's strength. The thousands of other corporate profit reports in the offing could make or break the market's 2007 rally.
In the first quarter, unexpectedly strong corporate profits helped the market recover from a plunge in stock prices. Will this summer's profits push stocks back up to record levels, or be the start of a big correction? According to Reuters Estimates, analysts expect earnings of companies on the broad Standard & Poor's 500-stock index to rise 5.6% over the previous year.
"Those are low numbers," said Brian Gendreau, investment strategist at ING Investment Management. "Estimates that low are just begging to be beaten."
Last quarter, according to Reuters Estimates, S&P 500 firms beat estimates by an average of 5.6% to post earnings-per-share growth of 8.6%. Stocks rallied as a result. But assuming companies can surprise the analysts again, will the market react the same way?
Pressure's On to Impress Investors
Maybe not. Analysts usually underestimate corporate profits, so equity investors may be expecting more upside than the spreadsheet crowd. Plus, last quarter the mood on Wall Street was very different. A sell-off in China had unnerved markets around the world, and the economy was barely growing at all. "Last quarter, investors were feeling down and out before earnings season," said Chris Johnson of the Johnson Research Group. With the economy reviving from a weak first quarter, there's more optimism out there now, so it will be harder for companies to impress Wall Street. Last quarter, investors expected the worst and were pleasantly surprised. This quarter, "there's more pressure," he said, with less tolerance for error.
The U.S. economy grew at a rate of only 0.7% in the first quarter. There are signs the economy is recovering, but there's no doubt companies are seeing slower growth in 2007 than in previous years. So far, this slowdown hasn't scared investors too much, with stocks just below record prices. That's partly because investors expect better times soon.
"The market expects stocks to eventually rebound as the economy does later this year and into 2008," Gendreau said.
Earnings are expected to grow at a single-digit rate this quarter, as well as in the third quarter. Reuters Estimates says analysts expect only a 2.9% year-over-year growth in earnings in the third quarter. But earnings are expected to grow 13% in the fourth quarter and 12.8% for all of 2008, according to Reuters Estimates.
So far, corporate profits have outpaced the U.S. economy, partly because of hot foreign economies, especially in Asia. Gendreau points out that almost half of revenues from the 30 members of the Dow Jones industrial average come from overseas. In the past, the markets have underestimated how much overseas profits help U.S. stocks, but investors may be learning, Gendreau said.
Last year, 43.5% of Alcoa's revenues came from outside the U.S.
Next Week Will Set the Tone
How big is the impact of Alcoa's first-on-the-Street earnings report? Can it set the tone for the rest of earnings season? Analysts disagree. Monday's mediocre results are unlikely to have much psychological impact. But a big surprise from Alcoa could have either lowered or raised expectations, says Todd Salamone of Schaeffer's Investment Research.
However, Johnson notes that Alcoa will quickly be overshadowed by other big firms' profit reports. This week, companies such as General Electric (GE) also announce earnings. But expect the big fireworks during the week of July 16 to July 20, when more than 200 companies post profits. "Next week should set the tone for where this earnings season is going to go," Johnson said.