Earnings: A Longer-Term View

Last quarter, 73% of Standard & Poor's 500-stock index companies beat profit expectations, and this earnings season should offer more of the same. Of the 14 companies that reported earnings from Sept. 28 through Oct. 9, 12 made more money than analysts' best guesses. But knowing positive surprises are on the way doesn't make picking winners any easier. Of the 12 companies that surpassed their numbers, half saw their shares fall during the next trading session. Even big gainers Walgreen (WAG), Jabil Circuit (JBL), and Nike (NKE), which all saw shares climb more than 7%, are not sure long-term bets. "There's too much focus on current earnings," says Karl Mills, manager of the large-cap CounterPoint Select Fund. "It's what you can glean about the future that's important." Here's how some money managers are parsing recent earnings reports.

WALGREEN: Welcome Back? The Move: Investors sent shares of Walgreen up 9.2% on Sept. 29 when it reported earnings of 44 cents a share, 5 cents better than expectations. The Backstory: It wasn't just beating estimates that boosted shares. A year ago, Walgreen acknowledged that its costs had become bloated and laid out a plan that included cutting expenses by $1 billion and lowering the number of store products. Ever since, investors have been looking for signs of a turnaround. Early results were ugly. Cutting the product mix meant unwanted inventory had to be sold at deep discounts. Gross margins, which had been falling, kept plummeting. The Outlook: Margins finally turned positive this quarter, and Walgreen said 70% of the inventory cutback is complete. With 30% to go, margins should keep rising. "This quarter is further evidence that the turnaround will bear fruit," says Jason Tauber, a vice-president with Neuberger Berman's (NBCIX) Large Cap Disciplined Growth group, which owns the stock.

JABIL CIRCUIT: Great Expectations The Move: Jabil investors anticipated good things coming into its Sept. 29 earnings announcement. The circuit board manufacturer didn't disappoint: Jabil made 16 cents a share, doubling the consensus view of 8 cents. Revenues were $2.8 billion, beating the consensus by $150 million. The stock rose 12.3% on Sept. 30. The Backstory: Jabil said that next quarter's sales would top $3 billion, $120 million more than analysts had expected and that earnings would be 24 cents to 32 cents a share, well above predictions. Even contribution margins—the profit made from each sale once fixed costs are subtracted—topped predictions at 19.7%. "Investors didn't expect them to hit these numbers for four more quarters," says Credit Suisse Group (CS) analyst William Stein. The Outlook: For Jabil's streak to continue, its customers, including Cisco Systems (CSCO) and Hewlett-Packard (HPQ), have to do well. So Andrew Corn, chief investment officer for equities at Beacon Trust, is watching earnings reports closely. (He isn't ready to buy the stock just yet.) Those reports will go a long way toward predicting whether the company can repeat its performance next quarter—and whether Beacon will be buying. "The big news is that they beat on revenues," Corn says. "But is that growth sustainable?"

NIKE: Just Doing It The Move: At first glance, Nike's earnings report wasn't very impressive. Sure, profits came in at $1.04 a share, 7 cents better than the consensus. But revenues dropped 12%, and the number of orders it expects to fill in the next quarter dropped 6%. After digesting the news overnight, investors sent shares up 7.7%. The Backstory: Those numbers are an overall improvement. Future orders had dropped 12% last quarter, while North American clothing sales fell 8.8%, an improvement over last quarter's 15.4%. The Outlook: Be cautious, says Stephen K. Shueh, managing partner at Princeton (N.J.)-based Roundview Capital. Investors know Nike's business is improving, and its 63.68 price reflects a reasonable valuation relative to its current profits.

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