For all the concerns in financial markets about the fiscal crisis swirling around Greece and the broader European economy, it's easy to forget that U.S. companies are celebrating impressive profits.
With results so far from 85 percent of the large-cap companies in the broad Standard & Poor's 500-stock index, earnings are up 56.5 percent in the first quarter from a year earlier. The average company beat the estimates of analysts surveyed by Bloomberg by 15.6 percent.
The latest big-name company to report better-than-expected results is Walt Disney Co. (DIS), which posted earnings of 48 cents per share on May 11, exceeding analyst estimates of 46 cents and results from a year earlier of 33 cents.
The stock market seemed to initially celebrate these profits, with the S&P 500 rising 4.1 percent from the end of the quarter to Apr. 23. Since then, however, the index has dropped 5.1 percent.
One explanation for the market's reaction is outside events, particularly the debt crisis in Greece.
"Macro concerns have intruded and made the current earnings in a way irrelevant," says Bill Stone, chief investment strategist at PNC Asset Management Group (PNC).
Profits are a key measure for value investors, often cited to justify stock prices. One result of the recent market pullback is that stocks now look less expensive.
"Earnings have gone up, and the market has not," says Terry Morris, senior equity manager at National Penn Investors Trust Co. "That itself improves valuations."
The price-to-earnings ratio of the S&P 500 on May 11 was 16.8, down from 17.7 on Apr. 23.
However, first-quarter results aren't a reliable valuation guidepost if they're "the peak," reflecting an economy that can't keep up the current pace of growth, Stone says. "The worst-case scenario around Greece is that it causes a contagion and [slows] down the global economy."
Some bearish market observers, while acknowledging earnings have been good, say they haven't been good enough.
"Expectations were so high," says Bruce Bittles, chief investment strategist at Robert W. Baird. Even as companies have beaten analyst estimates, he says, they had trouble topping the hopes of investors who have pushed the S&P 500 up 71 percent since Mar. 9, 2009.
The market also may have been expecting more revenue growth, rather than merely profit growth driven by cost-cutting, Morris says.
According to Bloomberg data, S&P 500 revenues have risen 13 percent from a year earlier, with the average company beating analyst estimates by 1.1 percent. "It's a little bit better," Morris says, but investors were hoping for more. For the most part, he says, "these companies are getting their earnings through cost-cuts and not through demand."
PNC's Stone, however, looks on the bright side—that revenues are actually rising. "The global economic recovery is translating into sales for corporations," he says. "It's not just cost-cutting anymore."
One of the more surprising features of the most recent earnings season was strong profits in the consumer discretionary sector, which includes retailers, restaurants, and other consumer-focused businesses.
"The consumer is not dead," says Michael Yoshikami, president and chief investment strategist at YCMNET Advisors. "That's the biggest thing I'm taking away from earnings [season]."
Earnings for the S&P 500 consumer discretionary sector have rebounded 315.4 percent from a year earlier, and the average company beat estimates by 22.5 percent, according to Bloomberg. In turn, investors have rewarded the sector, which has risen 3.1 percent since the quarter began, more than any other sector.
Bearish investors like Baird's Bittles believe the consumer's momentum can't be continued, especially against the backdrop of high unemployment. "Consumer balance sheets are still weak and need to be repaired," he says.
The key question for investors is whether the first quarter's good news—which included higher U.S. consumer spending, improvement in other economic data, and especially the corporate profit rebound—can continue through the rest of the year. "All the concern has to do with the trajectory and strength of the recovery," says USAA portfolio manager Bernie Williams.
Earnings have been propped up by government stimulus, cost-cutting, and the benefit of last year's weak dollar, Bittles argues. "Expectations are very optimistic for the balance of this year and next year," he says.
Others are less pessimistic. "There's little doubt that the economy is starting to improve," Yoshikami says. Eventually, the market will catch up to the improving fundamentals, he adds. "Once the dust settles, people are going to realize that earnings have been surprisingly good."
Steverman is a reporter for Bloomberg Businessweek's Finance channel.
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