4th-quarter earnings to be tough to beat

By Matt Kratz
USA Today

Now that Corporate America has reported its best quarterly earnings in more than a decade, investors are wondering what's next.

More likely than not, they won't see another quarter like the fourth quarter, at least not in this economic cycle. Operating earnings jumped 19.6 percent, with 77 percent of the companies in the Standard & Poor's 500 reporting, S&P says. By the time all companies have reported, growth is expected to come in at 25.3 percent. Based on official accounting standards that include Time Warner's $45.5 billion charge in the fourth quarter of 2002, earnings jumped 629 percent.

The blow-out quarter shows that there was good reason for the optimism that drove the stock market up 26 percent last year, says Sam Stovall, strategist at S&P. "That was the big kahuna with the wave of better-than-expected earnings reports," he says.

But while fourth-quarter earnings were strong, that was in large part because earnings were so depressed a year earlier. While the easy comparisons are now gone, analysts say the fourth quarter gives clues how the earnings recovery will look as it matures:

The winners are beating the pack by a wide margin. Consider information technology, which had 97.2 percent earnings growth, making it the best sector. Next best: Materials companies — makers of metal, plastic and paper — blasted ahead with 76.5 percent growth.

Those sectors benefited most because demand for their goods grows extraordinarily fast once an economic recovery takes hold, Stovall says. Both have also spent the past years cutting costs, making them more profitable now.

Stovall thinks these sectors have so much going for them, they'll be the earnings winners this year.

Telecom's results are still ailing. Telecom stocks have been on a tear since late last year, but their earnings still aren't. The sector was the only one of the 10 tracked by S&P that posted lower earnings than a year ago.

Jim Paulsen, strategist at Wells Fargo Capital Management, says telecom troubles are much deeper than some investors had hoped.

Many telecoms are still paying dearly for their borrowing binge in the 1990s with steep interest costs. While interest rates might be low, the prices telecom companies charge for their services are falling, leaving them with less to make the hefty debt payments. In addition, there's still so much excess capacity that a further "shakeout" is needed, Paulsen says.

Estimates are still muted. Roughly 66 percent of the companies that have reported results beat estimates, First Call says. That's well above the 58 percent of companies that typically beat estimates. On average, the companies topped estimates by 5.2 percent, 2.2 percentage points above usual.

So far, estimates remain reasonable for the first and second quarter, says Chuck Hill, director of research at First Call. But he worries second-half estimates might be too aggressive and tough to beat.