Making the Most of Earnings Season

There's good reason to be cautious.

Tim MicKey

Earnings season is when analysts generally start to increase earnings expectations, as a majority of companies tend to beat consensus estimates. As dangerous as it is to say “this time it’s different,” I am going to say it: “This time it’s different.”

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While corporate profits have been a driving force behind the latest bull market that began in 2009, the three-year run of seemingly uninterrupted increased earnings may be coming to an end. What’s different now is that there has been a significant increase in the number of corporations reporting earnings below their estimates.

According to Thompson Reuters Research, as of February 10, of the 352 companies in the S&P 500 that have reported earnings for the fourth quarter of 2011, 63 percent reported earnings above analyst expectations, 11 percent reported earnings in line with expectations, and 26 percent reported earnings below estimates. This compares to a historical average (since 1994) of 62 percent beating estimates, 18 percent matching estimates, and 20 percent missing estimates. Over the last four quarters, it has been 70 percent beating, 10 percent matching, and 20 percent missing estimates. The increase in the number of companies reporting below-consensus estimates is worth paying close attention to.

[See Understanding Earnings and Earnings Estimates]

With the indexes closing in on 52-week highs, it’s a good time to consider decreasing your portfolio’s exposure to sectors that may be missing their estimates and increasing exposure to sectors where estimates continue to rise.  According to Bespoke Investment Group, of the ten sectors that make up the S&P 500, seven sectors had net revisions ratios decline and three sectors had increases. Those three are Industrials, materials, and consumer discretionary. The worst-performing sectors were utilities, telecom services, and energy.

[See Investing: It's All About Expectations]

It’s also important to note that the earnings increases over the past few years have largely been sustained without the assistance of significant revenue increases. If we look at the 346 companies in the S&P 500 Index that have already reported earnings, 55 percent reported revenues above expectations and 45 percent reported revenues below expectations. The energy sector is expected to have the highest revenue growth for 2012, with financials expected to post the lowest.

Pre-announcements are always worth watching. This is when companies attempt to let investors know what to expect before the quarter is over. The number of companies that have issued negative earnings per share pre-announcements for the first quarter of 2012 is also above historical averages.

I believe that earnings will continue to increase for 2012, but to a lesser extent than they have over the past few years. As the economy continues to gain strength, it makes sense to consider staying invested in sectors that show the highest percentage increase in earnings and to look for companies with increasing revenues.

Timothy S. MicKey, CFP®, is a managing director and cofounder of Monument Wealth Management in Alexandria, Va., a full-service investment and wealth management firm. Monument Wealth Management is backed by LPL Financial, an independent broker-dealer and Registered Investment Advisor, member FINRA/SIPC. Monument Wealth Management has been featured in several national media sources over the past several years. Follow Tim and Monument Wealth Management on their blog Off The Wall, on Twitter at @MonumentWealth and @TimothySMickey, and on their Facebook page. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for individuals. To determine which investment is appropriate, please consult your financial advisor prior to investing. All performance references are historical and are not a guarantee of future results.