Wednesday, January 22, 2014

Earnings & Deflation (excerpt)

So far, the earnings season has been on the disappointing side. That’s somewhat surprising given the apparent strength of the economy at the end of last year. Yesterday’s Morning Briefing was focused on deflation. Perhaps this is becoming an issue for earnings. It certainly has for some retailers, as I noted yesterday. The big debate about earnings in recent months has focused on whether profit margins might get squeezed by more business spending on labor and capital. Perhaps we need to pay more attention to the pricing environment for signs of deflation. We intend to do just that in coming weeks.

Productivity is a wonderful thing. It usually boosts both corporate profits and labor incomes. Historically, there has been a strong correlation between productivity and real pay per worker. However, the technology revolution may be putting productivity on steroids, leading to the commoditization of more and more goods and services. Commoditization is always bad for profit margins because it is fundamentally deflationary. To stay in business in a commoditized business, you have to use more technology to lower your labor costs.

Let’s turn from theory to hard data:

(1) Earnings during Q4-2013. It’s not over yet, but this is turning out to be a very unusual earnings season. During each of the previous three earnings seasons last year, analysts lowered their estimates as the season approached. That set up investors to be pleasantly surprised as actual earnings turned out to be a bit better than expected.

So far, there has been no similar curve ball. Instead, during the week of 1/16, the blended actual/estimate for Q4 fell to a new low for the weekly series. The current projected growth rate for the quarter is just 6.6% y/y.

(2) Quarterly earnings during 2014. Previously, I’ve argued that Q4-2013 earnings don’t matter unless they significantly change expectations for 2014 and 2015, the current and the coming years that we use to calculate forward earnings. The latest consensus estimates for each of the four quarters of this year have been on downtrends since mid-2013. However, during the first two weeks of January, the Q1 and Q2 estimates have stabilized, while the Q3 and Q4 estimates have continued to fall. So, it’s not clear that the latest earnings season is having much of an impact on this year’s estimates.

Today's Morning Briefing: (1)Valuation, Earnings, & Deflation. A dull start to a dull year? (2) Good, not great expectations. (3) Stocks were a great buy during August 2011. Not so much now. (4) Slightly overvalued using forward P/E. (5) Some very pricey industries. (6) Earnings-driven stock market this year. (7) Earnings should be up 10% in 2014. (8) So why is Q4-2013 disappointing so far? (9) Deflation may be a problem for margins. (10) The commoditization challenge. (More for subscribers.)

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