Video: Healthy profits expected

updated 1/8/2004 6:40:25 PM ET 2004-01-08T23:40:25

Fourth-quarter earnings season gets rolling on Wall Street this week and most analysts are looking forward to a healthy hike in profits, as corporate America continues to benefit from such factors as fiscal stimulus, the economic recovery and record-low interest rates.

A consensus of Wall Street analysts polled by research firm Thomson/First Call expects companies in the Standard & Poor's 500-stock index, a broad market measure, to report earnings climbed 22.3 percent in the fourth quarter from the same period last year.

“In the end it will be more like 26 percent,” said Joseph Cooper, a research analyst at Thomson First Call. Such a gain would make the quarter’s earnings the best since the third quarter of 1993, when profits rose 30 percent from the same period a year before, he noted.

But with the broader U.S. stock market up over 40 percent after a 10-month bull run, analysts say the good news about earnings is already widely anticipated. Many are more concerned with how earnings will fare this year, and so this earnings season they will be closely following firms’ comments about future quarters and about the whole of 2004.

“In 2003, firms were loath to give guidance further than one quarter out, so it will be interesting to see if we get more forward-looking statements this quarter,” said Cooper. If firms are willing to make long-term forecasts it could mean their leaders are more confident, and it may ultimately lift stock prices, he added.

Alcoa kicks off reporting period
The release of aluminum heavyweight and Dow Jones industrials component Alcoa’s earnings report late Thursday marked the unofficial start of the fourth-quarter earnings reporting period. The company posted fourth-quarter income from continuing operations of $340 million, or 39 cents a share. In the comparable period last year, the Pittsburgh-based aluminum producer recorded a loss from continuing operations of $146 million, or 17 cents a share.

Analysts on average expected earnings of 34 cents a share, according to Reuters Research.

Over the next week or so, a handful of high-tech bellwethers like Apple, Intel, Yahoo! and Sun Microsystems, and a few big banks, will deliver their profit reports. The floodgates open the following week, when 125 companies in the S&P 500 index report their earnings.

Fourth-quarter earnings should hit an all-time high for 2003, capping a 17-percent rise for the year as a whole -- the best year for earnings since 1999, according to Thomson/First Call. A reason for the buoyant outlook is the very low ratio of negative to positive pre-announcements, when companies say whether or not they’ll meet financial forecasts.

Roughly 350 companies in the S&P 500 have already offered Wall Street a glimpse of their quarterly results, with about 1.3 negative pre-announcements for every positive pre-announcement. That beats out the average ratio over the past nine years of roughly 2.5 negative pre-announcements for each positive forecast, according to Thomson/First Call.

Techs, financials seen shining
The quarter’s best-performing sectors are expected to be the financials and technology, but the biggest growth will be seen in basic materials, reflecting rising commodity prices and indicating the global economy is recovering as demand for products like metal and paper grows, according to Cooper.

Major Market Indices

When companies deliver their quarterly scorecards, market analysts like Peter Dunay, chief investment strategist at brokerage firm Wall Street Access, will be looking for information on their spending habits. Dunay said he wants to see if businesses are spending and contributing to economic growth, particularly by hiring new workers.

“The consumer was a major contributor to strong economic growth in late 2003 and we want to see businesses contribute too,” he said. “If businesses can’t support the consumer by investing in new hires it may present problems for us down the road,” he noted.

Evidence of decent revenue growth will also be important, Dunay added, as it will offer evidence that companies are not simply propping up earnings through cutting costs. Good revenue data will also show companies are able to continue to grow earnings, he added.

“So much of the stimulus we’ve had was borrowed from the future in the form of tax cuts and lower interest rates, and in the future that stimulus won’t be there to prop us up,” Dunay said. “This really becomes a concern at the end of 2004 and going into 2005, because that’s when the earnings comparisons with prior quarters will be harder.”

It's not that anyone is forecasting a free-fall in profits in 2004.

Companies are expected to show healthy gains in coming quarters, but the pace of growth isn’t expected to be as strong as in the recent past, largely because of companies adding on expenses to keep up with the growing economy. The big unknown is how investors will react, say analysts. Will they latch on to the good news about the economy or worry earnings have peaked?

Most investors are growing more confident that a recovery in corporate profits and the economy is on the cards, but lofty share prices are becoming a concern. Dunay reckons the market is likely to see some form of correction in the near future, although he doesn’t think it will be an aggressive decline.

“The market has factored in so much earnings strength there’s very little upside for positive news,” he said. “Momentum is driving us higher. We’re stepping away from a market driven by fundamentals to a market where everyone wants to jump on the bandwagon so it feels as though we’re overextended and about to pull back.”

Chip Hanlon, chief domestic strategist at Euro Pacific Capital, is more bearish.

“Earnings will be fairly positive in relation to estimates, but the market has already factored this in and we have yet to see proof that the economic recovery is sustainable and not built on the stimulus from tax cuts and lower interest rates. I might change my mind if the market manages to push up to new highs, but I don’t think it will,” said Hanlon.

However, Sam Stovall, chief investment strategist at Standard & Poor's, notes that even if profit growth slows in future quarters, it won’t necessarily mean investors will run for the exits, as earnings and the market don't always move in lockstep.

Over the last 40 years, the market has actually accelerated six out of 10 times after earnings peaked and growth began to slide, according to Stovall.

From June 1988 through September 1989, for example, when earnings for the S&P 500 went from a 50.3 percent expansion rate to a 4.3 percent year-over-year increase, the S&P 500 stock index advanced 28 percent.

The Associated Press and Reuters contributed to this report.

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