There seems to be a general consensus that 1Q09 earnings were better than expected. That was certainly true for the banking sector which reported some strong headline numbers but that under the surface showed low quality and in some cases dubious earnings. However a closer look at analysts estimates before, during and at the end of 1Q09 reporting seasnon shows that overall it was on the disappointing side.
As can be seen above, in late February, before any of the brokers had reported, S&P500 operating earnings were expected to come in at around $13.75 for 1Q09. By the end of March before reporting season really got under way, estimates were down just below $13.00. The first few weeks of earnings reports were looking positive and by the end of April the March estimates were holding up reaonsably well. However, as we got deeper into reporting season the numbers deteriorated and by the end of May with 99% of reports in, S&P500 operating earnings were down to $10.14.
On a full year basis, S&P500 operating earnings for FY09 are now estimated at $54.09 down from $62.36 before 1Q09 earnings season began. As usual, analysts are trapped in their linear world of forecasts expecting an earnings recovery every quarter from now out to the end of 2010. As mentioned in previous posts, prior to the early 90′s recession earnings peaked in June 1989 and did not reach that peak again until 4 years later in June 1993.
Currently analysts are expecting earnings to recapture the Jun 2007 highs in about the same time frame as the early 90′s, in 4 years or by mid 2011. Given the depth of the current recession, the continued deleveraging of the household and corporate sectors and the unlikelihood of a return to the record profit margins of the last decade, it seems somewhat optimistic to expect earnings to come roaring back to record highs in the next 2 years.
Turning to reported earnings which includes all the bad stuff. Current estimates have S&P500 earnings at just $27.45 for FY09 and based on an S&P500 of 939 puts the FY09 P/E at well over 30x. However it pays to be a little more rigorous than that and so adopting Robert Shiller’s 10 year average earnings method we get a FY09 P/E of just over 19x, hardly what you’d call compelling.
Note that unlike Shiller I have not adjusted for inflation so my average PE of 17.7x is higher than Shiller’s at about 16.0x. Whether you adjust for inflation or not, the message is the same, the S&P500 P/E is above its long term average and as the chart above shows, it has gotten nowhere near the type of trough multiples experienced in the bear markets of the early 1970′s and 1980′s.
Doug Cass of Seabreeze partners recently made the interesting observation that although 67% of companies beat earnings estimates in the lastest quarter, 63% failed to meet revenue targets. So how did so many beat earnings estimates? Obviously through slash and burn type cost cutting. However you can’t cost cut your way to prosperity over the long term, you need top line growth to return and I have no doubt that at some point it will, I just don’t think it will be as soon as most analysts expect.