Earnings Estimates Are Likely to Come Down

While third-quarter profits came in slightly lower than expected, the attention has now shifted to 2009 and the impact of the economic slowdown

Though fourth-quarter earnings estimates still paint a rosy picture, they are likely to be cut significantly by the end of November.

After all, this is the time of the year when the next year begins to become a reality. The fourth quarter is infamous for writedowns and Standard & Poor’s Index Services, which operates independently of S&P Equity Research, believes impairment charges will be significant. Additionally, layoffs, both current and planned, are becoming more common, along with their associated costs and initial short-term cash outflows (severance).

All-in-all, estimates are getting more difficult and more complex to make, with different assumptions leading to widely varying predictions.

With 77% of third-quarter earnings for companies in the S&P 500 reported through Oct. 31, it appears as if the quarter, which was expected to realize an earnings gain of 14.2%, should come in at -13.4%. Financials continue to be the problem (the sector should easily post its fourth consecutive quarter of negative earnings), and consumer discretionary helped to bring the overall numbers down. Specifically, recent layoff announcements feed the "I could be next" fear, leading most to believe that consumers will pull back even further, and while a lump of coal may not be the holiday gift of choice, the purchases this year will be more selective and closer to the "need" than "want" category.


We now expect a 2008 dividend payment for the S&P 500 of $28.05 vs. our previous estimate of $28.85.

In 2007, the payment was $27.73. The 1.2% expected 2008 increase is the lowest growth rate since 2001 when payments were down 3.3%.

We don’t expect the full impact of the annual dividend reductions to be felt until 2009. We do see a 10% decline in the fourth-quarter 2008 payment compared with the fourth-quarter 2007 outlay, the worst quarterly change since 1958. Sixteen financial dividend cuts in September and October lowered dividend payments by $14.6 billion.

We will provide our 2009 dividend estimate later in the fourth quarter. Given the current economic climate, 2009 dividend increases are expected to slow.

In October, there were 10 increases and 12 declines. At least in recent history, there has been no month (before October) where the negative announcements outnumber the positive ones; the prior worst month was +6 and that was in September. Worse has been the dollar loss, with $8.5 billion in reductions, and $0.5 billion in increases for October; year-to-date, there have been $33.2 billion in reductions, which easily outweighs the $18.0 billion in increases. Financials accounted for 92.7% of the dollar damage.

Payers’ stocks outperformed those of non-payers for all periods: the month posted -20.9% return for payers vs. a -21.9% loss for non-payers, year-to-date (-34.7% vs. -38.8%), and the 12-month period (-38.6% vs. -44.9%). While none of the returns are good, dividend payers have clearly performed better. Their long-term return, based on an annual portfolio of payers vs. non-payers is +2.4% (basically your yield) per year compounded over non-payers, or $133,652 on an initial $10,000 investment made in 1979.


Last year, S&P 500 companies were able to brag that their pension funds were over-funded by $63 billion, a value not seen since 1995. It's now 10 months later, and at this point, it looks like they are on the way to reporting the largest under-funding in history.

Going into the year, the companies estimated an 8% return on their pension assets for 2008, and used those numbers in their reporting, allocations, and planned contributions. They had 61% of their money in equity, 32% in fixed income, 2% in real estate, and 5% in the catch-all other category. They also had 15% in foreign markets, which significantly helped them obtain that over-funding status last year.

While someone might be achieving 8%, the reality is that any pension fund manager that is even breaking even this year is most likely demanding a bonus. The U.S. market is down more than 33%, and that's good compared to the emerging markets, which have fallen more than 50% this year alone. That means the 61% allocation to equity may not be doing that well. Interest rates are down, but the key to the 32% in fixed income is the investment choices. When you calculate everything at the current market returns, or even assuming a nice fourth-quarter rebound, you arrive at a number that is worse than the $219 billion in under-funding reported in 2002, and that's after starting from the positive 2007 $63 billion position.

Since 2002, the accounting requirements have changed, and companies now have to put their funding status on the balance sheet. Since assets still equal liabilities, equity will have to be marked down. The under-funding will also have to be addressed with large unplanned cash infusions, which will come at a time when liquidity is tight.

Overall, we expect few companies to remain over-funded and think the payments will add more pressure on companies to reduce the already dwindling number of defined pension programs out there.