Corporate America is turning a profit again, but only by spending less, not making more.
While recent bullish profit reports have fueled the stock market, a true economic revival will depend on consumers opening their wallets. So far, there's little evidence of that.
Big names such as Caterpillar, IBM, Whirlpool, Pfizer, 3M and Lowe's boosted profit forecasts for 2009 following a slew of second-quarter earning reports that blew past lackluster expectations. Yet the gains aren't coming from sales.
Rather, companies are slashing everything from jobs to perks to boost the bottom line and please investors who have responded by pushing the major stock indexes to their highest levels in months.
None of this is surprising coming out of a recession. But the increase in the major stock indexes is raising questions about whether investors are getting ahead of themselves. Companies can only cut costs so much, and the profits and the stock surge aren't likely to last without a sustained economic recovery that puts people in the mood to spend again.
"Cost saving is not going to be the source of future earnings," said Fred Fraenkel, vice chairman of the Beacon Trust Company, an investment management firm. "The source is going to be revenue, and that can't happen until the economy starts growing."
Cost reductions are paying off
Many companies are taking steps that could lead to even better year-over-year earnings growth in the third and fourth quarters. Last year, companies were unprepared for the plunge in consumer spending that followed the credit crisis and stock market collapse in September and October. Revenue fell sharply, but there wasn't enough time to cut costs, so profits tumbled.
Now, months of cost reductions are paying off, and investors are eating it up. The Standard & Poor's 500 stock index has shot up 44 percent since early March, while the Dow Jones industrials jumped above 9,000 Thursday for the first time since early January. On Friday, the Dow rose 23.95, or 0.3 percent, to 9,093.24.
Edward Yardeni, an independent market analyst, said the rally is justified. "But if all these companies do is cut costs and they can't find ways to expand revenue, all they're doing is shrinking and that's not bullish," he said.
Companies have cut spending in big and small ways. At Google, employees no longer get free bottled water. Starbucks, meanwhile, has shuttered hundreds of stores.
The frugality is paying off. Of the nearly one-third of the nation's largest companies that have reported second-quarter earnings so far, 76 percent have topped analyst expectations, according to Thomson Reuters.
And despite the severity of the downturn, less than a fifth of U.S. companies are losing money, according to Cary Leahey, an economist at consulting firm Decision Economics.
"They've done extraordinary belt-tightening," he said.
For earnings to keep rising, consumers must start spending again. And unless economic activity overseas improves, U.S. companies that do business abroad will continue to suffer, dragging down everyone.
‘Only the strong survive’
The dismal spending climate has hurt big companies like Microsoft and Amazon.com, which reported disappointing quarterly earnings Thursday.
At IBM, layoffs, automation and other cost-cutting measures helped the company blow away quarterly earnings projections last week. The revenue picture was less encouraging. IBM's sales dropped 13 percent to $23.25 billion, below the $23.59 billion predicted by analysts. Still, the company raised its full-year profit forecast.
"Bottom line, the changes to the company have allowed us to deliver strong performance in a tough environment," IBM chief financial officer Mark Loughridge told analysts, predicting the company will "come out even stronger when the economy improves."
Ford Motor Co. notched a $2.3 billion profit in the second quarter, a year after suffering the worst loss in company history. The surprise gains came as the struggling Detroit automaker reduced debt and trimmed its payroll, including 1,000 blue-collar job cuts through buyout and early retirement offers.
"Without those measures, they'd be in an entirely different situation as a company," said Aaron Bragman, an analyst for the consulting firm IHS Global Insight. He noted Ford had little choice to cut back to offset flagging sales, which fell 14 percent in June compared to the same month last year.
Even the battered banking industry is joining the earnings bonanza, with Wells Fargo & Co., Bank of America Corp. and Citigroup Inc. all posting profitable second quarters.
The gains stand in marked contrast with the stunning losses and financial market upheaval seen only six months ago. Gone are the days when experts fretted about the possibility of another depression. Now the talk centers on whether the economy will recover early next year, and the question is whether it will happen fast enough for many companies.
"Many companies are going to look good now," said Joe Battipaglia, market strategist for private client group at Stifel Nicolaus. But if revenue remain flat and companies run out of ways to save money, "it becomes economic Darwinism where only the strong survive."