With over half of the S&P 500 earnings reported(report)the numbers are coming in ahead of expectation, which considering two thirds of the issues historically beat their estimates, doesn’t say that much. Specifically 65% of the issues beat their operating estimate, with 44% beating last year’s earnings; 68% beat their sales, with just 29% beating their last year’s sales and 45% of the companies beat their As Reported number from last year. So far there have been few items and fewer major charges, as evident by the fact that the bottom line for both Operating and As Reported, at least so far, are the same. Several companies however have announced plans to do layoffs, which will result in those infamous year-end write-offs creating a GAAP between the Operating and As Reported earnings. Last year was a banner year for write-offs, write-downs and provisions, resulting in the only negative quarter for earnings in index history – both on Operating and As Reported basis. Based on the reported data the stats are improving, but they need to be viewed against the guidance, the easy comparatives from last year, and more importantly, measured against the perceived stage of the recovery.
The real story is in the cost cutting and the sales. This year companies have cut their way to the bottom line. While sales have dropped by a double digit number, which normally would devastate the bottom line, but aggressive cost cutting, prior layoffs and a lack of corporate spending has managed to limit the damage. The result is that margins have been improved. The concept is that eventual higher sales will produce much higher earnings; the reality is that we are paying 28 times current earnings for the belief in that concept. Q3 is giving a sign that support the concept. Sales for this quarter are coming in 3.65% ahead of estimates, with earnings ahead 7.60%, resulting in an above average margin of 8.17%. And while year over year sales are expected to decline 10%, that is significantly better than the 19.9% decline in Q2 or the 16.5% drop in Q1 – less worse is better has come to sales.
So the $1.5 trillion question is, $1.5 trillion is how much sales have declined over the past year, where will the sales come from? A smaller part will come from increased consumer and corporate spending, inspired by a more optimistic outlook and by the need to replace outdated items that can’t be put off any longer; a potential Accelerated Depreciation bill is on the table, but not the Floor yet would also help. The larger part however may come from M&A. In this case companies have plenty of cash and shares, and the market seems ready to get back into the grove for Monday Morning Merger Mania.