Sell Signal on 36% Profit Increase Has Analysts in Math Denial
Meyer Shields says earnings at Warren Buffett’s Berkshire Hathaway Inc. will increase the most since 2006 this year. He’s also telling investors to sell the shares because the economic recovery is weakening.
The Stifel Nicolaus & Co. analyst has plenty of company. For the first time since at least 1997, fewer than 29 percent of ratings for stocks covered by brokerages worldwide are “buys,” according to 159,919 recommendations compiled by Bloomberg. Analysts are turning more pessimistic even as they push up estimates for profit growth among Standard & Poor’s 500 Index companies to 36 percent, the highest since 1988.
“People are sitting on a fence,” said Paul Zemsky, the New York-based head of asset allocation for ING Investment Management, which oversees $550 billion. “When I go and talk to our equity analysts, they look at the companies and say, ‘Boy these companies look pretty good, earnings are OK, they have plenty of cash. What if there’s a double dip?’”
Conflicting announcements two minutes apart by Intel Corp. and Federal Reserve Chairman Ben S. Bernanke last week underscore the challenges facing analysts and investors even as stocks trade at a lower price relative to estimated earnings than almost any time on record. Intel cut its third-quarter revenue forecast, citing weaker-than-expected consumer demand. Bernanke said the central bank “will do all that it can” to safeguard the recovery.
More than 54 percent of ratings for companies in the U.S., U.K., Japan and Brazil are “holds,” the highest level since Bloomberg began tracking the data in 1997. While the proportion of “sell” ratings in the U.S. has fallen to 5.1 percent, half the level of 2003, the total combined with “holds” reached a record 71 percent last month, the data show.
“A ‘neutral’ usually means historically a ‘sell,’” said Kevin Rendino, a money manager at New York-based BlackRock Inc., which oversees about $3.2 trillion. “Ratings chase stock prices. When everyone becomes risk averse, they don’t want to stick their necks out.”
While pessimism is increasing, analysts say profits for companies in the MSCI World Index of 24 developed nations will gain 28 percent in the next year. The MSCI index trades at 11.5 times forecast earnings, data compiled by Bloomberg show. Except for the six months starting October 2008, the index has never traded below 12.5 times reported earnings.
Trading on Aug. 27 illustrated the mixed messages facing investors this year.
Stock-index futures jumped at 8:30 a.m. when the Commerce Department revised its second-quarter economic growth estimate to a 1.6 percent annual pace, below the initial assessment of 2.4 percent reported last month, yet beating the 1.4 percent median forecast from a Bloomberg survey of 81 economists. The market opened higher, with the S&P 500 advancing 0.2 percent.
The gains were erased just before 10 a.m. when Intel said consumers were curtailing computer purchases. Two minutes later, Bernanke sparked a 1.7 percent rally in the S&P 500 by predicting an improving economy in 2011.
“This market has been whipsawing us back and forth,” said Mike Ryan, the New York-based head of wealth management research for the Americas at UBS Financial Services Inc., which oversees about $641 billion. “People are interpreting each and every data point either for validation or for repudiation of the view they hold.”
Gains on Aug. 27 trimmed the S&P 500’s weekly decline to 0.7 percent, closing at 1,064.59. The gauge fell 1.5 percent to 1,048.92 at 4 p.m. in New York.
The benchmark gauge for U.S. equities is down 4.5 percent in 2010 after Europe’s debt crisis wiped out an increase of as much as 9.2 percent. Citigroup’s Economic Surprise Index showing how much U.S. economic data is differing from forecasts fell to minus 64 on Aug. 25, the lowest since January 2009.
Analysts from Stifel’s Shields to Oppenheimer & Co.’s Rick Schafer and Anthony Gallo at Wells Fargo Securities LLC are advising clients against buying shares of Berkshire, Intel and C.H. Robinson Worldwide Inc. even after boosting profit forecasts.
Shields says his biggest concern is that joblessness will weaken consumer spending, which accounts for 70 percent of the American economy. The unemployment rate held at 9.5 percent for a second month in July and has fallen less than a percentage point from the 26-year high of 10.1 percent last year, according to the Labor Department in Washington.
“It’s negativity on the economy and therefore the ‘sell’ rating on Berkshire,” Shields said in an interview from Baltimore. “Employment is much worse than what people have anticipated. That uncertainty is contributing to weaker-than- desired employment and if I had to pick one single factor that underlies our negativity, that’s what it is.”
Shields forecast on Aug. 9 that Omaha, Nebraska-based Berkshire will earn $6,381 a share for all of 2010, an increase from his previous estimate of $5,866. The company’s Class A shares, which carry greater voting rights, have rallied 19 percent to $118,100 this year. The Class B stock of the firm, whose holdings in railroads, insurers and newspapers make it a proxy for the U.S. economy, rose 20 percent to $78.78 in 2010.
E. William Stone, chief investment strategist at PNC Wealth Management in Philadelphia, says rising “hold” and “sell” recommendations are bullish because it means investors can find bargains and wait for analysts to change their minds. He favors shares of technology makers and industrial companies.
‘A Little Nervous’
“Everybody is a little nervous to go out on the edge,” said Stone, whose firm oversees $103 billion. “That’s a positive. It gives the opportunity to either buy stuff that should be somewhere else. Maybe it’s a good company that’s being dragged down by the overall market.”
Profits for companies in the S&P 500 are forecast to reach $83.34 a share in 2010 and climb 22 percent in the next 12 months to a record $92.15 a share. Even slowing economic growth wouldn’t mean a stock-market crash, according to Laszlo Birinyi of Birinyi Associates Inc., which cut its year-end estimate for the S&P 500 to 1,225 from 1,325 on Aug. 25.
“While joblessness continues and the economy sputters, we would not necessarily ignore, but would instead downplay the vocal economists who believe another recession is upcoming,” the firm wrote. “There is a significant difference between the stock market and the economy. While both might be housed in the same building, they live on different floors.”
Higher earnings don’t always make shares attractive to investors. At American Express Co., improving profits reflect the reversal of previous bad-debt reserves rather than a revival in consumer spending, said Jason Arnold, an analyst at RBC Capital Markets. He raised his 2010 earnings estimate for the New York-based company to $2.89 a share from $2.54 a share on Aug. 1.
“The estimate increase doesn’t reflect our outlook for a dramatic improvement in fundamentals,” Arnold said in an interview from San Francisco. Earnings are growing “not because they are seeing a tremendous pick-up in core performance, but because they are releasing credit reserves and are cutting expenses. It’s been more of a sugar high,” he said.
The likelihood that Intel’s profit margins will narrow should keep investors from buying the stock, according to Schafer at Oppenheimer. The Denver-based analyst boosted his 2010 profit projection by 12 percent and raised his 2011 forecast by 13 percent on July 14, while telling clients to hold the shares.
“I’m no macroeconomist, but you’re certainly seeing data that suggests that things are slowing down,” Schafer said in an interview Aug. 26, the day before Intel lowered its sales forecast. “We’re underweight semis as a sector. We have seen peak earnings and most likely peak gross margins for this particular cycle.”
Schafer cut his 2010 and 2011 earnings estimates by 12 percent and 30 percent following Intel’s Aug. 27 announcement. The outlook from the Santa Clara, California-based company, whose chips run more than 80 percent of the world’s PCs, adds to evidence that the U.S. economic recovery is losing steam.
Wells Fargo analyst Anthony Gallo raised his 2010 profit forecast for C.H. Robinson last month and kept the “market perform” rating he has had since February. The Baltimore-based analyst said the transportation services company had earnings growth even as margins contract. He sees the shares as “fairly valued” given the economic uncertainties.
‘Hard to Envision’
“A catalyst on the horizon? It’s hard to envision one right now,” Gallo said in an interview. “We’ve seen a moderation in the rate of growth. We expect that to continue into the end of the year.” While expense cuts could help the Eden Prairie, Minnesota-based company, “it’s hard to see how that would be enough to continue to push estimates higher.”
The possibility revenue will disappoint investors is reason to sell shares of Dallas-based Texas Instruments Inc., said Daniel A. Berenbaum, who covers the stock for Auriga USA LLC, a New York-based research and trading company owned by Spanish investment firm Auriga Securities S.V. Sales at the second- largest U.S. chipmaker will surge 34 percent this year, rise 3 percent in 2011 and slump 1 percent in 2012, based on analysts’ estimates tracked by Bloomberg.
“The higher it goes now, the lower it could potentially go in the future,” said Berenbaum, who boosted his sales and earnings estimates for the technology maker last month. “I’m not inclined to raise my ‘sell’ rating.”
Wall Street firms are becoming more reluctant to award “buy” ratings because U.S. stocks are moving in lockstep with the S&P 500, limiting the opportunity for analysts to identify relative value, said John Praveen, chief investment strategist at Prudential International Investments Advisers LLC.
The correlation between the U.S. equity benchmark and its individual members was 0.81 in the 50 trading days through July 7 and has since remained close to that level, Birinyi data show. That’s almost twice the historical average of 0.45 from the past 30 years. A higher number means moves in individual stocks are increasingly related to the direction of the index as a whole and not on their own earnings prospects or valuation, the Westport, Connecticut-based research firm said.
“There’s a high amount of uncertainty,” said Newark, New Jersey-based Praveen, whose firm oversees $690 billion. “Analysts are trying not to stick out their necks. They are probably not really sure about how the economy is going to play out over the next couple of months. They are using that as an excuse to play it safe.”