Zacks Earnings Trends Highlights: American International Group, Home Depot, Lowe's and Macy's.

Zacks Research Director, Dirk Van Dijk says that S&P 500 earnings are continuing to show red ink. He tracks companies on the Zacks.com web site, naming names, while forecasting trends for the months ahead.

Key Points:

• We now have more positive revisions than cuts for 2009; 2010 gets close
• Reported Q1 total net income fell 31.7% from year ago, but was up 90.1% from Q4
• Excluding Financials, total earnings were down 35.5% from a year ago and 13.7% from Q4
• The decline is expected to continue in Q2, with a 36.4% year-over-year decline
• Total net income expected to fall 15.4% for all of 2009, after 19.3% fall in 2008
• Financials expected to rebound after disastrous 2008
• Bottom-up estimate for S&P 500 (SPX) now $57.25 in 2009 vs. $57.21 last week.
• S&P 500 now expected to earn $72.49 in 2010 versus $72.61 last week

Total Net Income Growth

The books are now closed on the first quarter earnings season. It was a book open to many interpretations, depending on which sort of spin you want to bring to it.

If you were inclined to be looking for green shoots, there was ammo for your argument in that the total net income reported was far higher (almost double) in the first quarter than in the fourth quarter of 2008. A bull would also be able to point to the fact that more than twice as many firms reported earnings above expectations than disappointed. The median surprise was a very healthy 4.35%.

A bull would also point to the huge increase in the number of upward estimate revisions for 2009 in response to the better-than-expected earnings. While estimate revisions activity always picks up in earnings season, the rise in the number of estimate increases absolutely swamped the rise in the number of cuts.

We are now past the peak of activity. Relative to a month ago, estimate increases are up 26.5%, while the number of estimate cuts has fallen by 24.4%. This has brought the revisions ratio from a negative 0.65 to a neutral/positive 1.09.

However, a bear would have ample ammo as well.

He would start by pointing out that total net income was 31.7% below year ago levels, and that the improvement relative to the fourth quarter was entirely due to one sector, the Financials. Furthermore the quality of earnings in that sector was abysmal, with billions of dollars of "profits" booked because the bond market had serious questions about the solvency of the firms. Also a very large portion of the increase came from one company, American International Group (NYSE: AIG) losing only $1.6 billion instead of losing $37.9 billion (both excluding one-time items).

If we look at just the 412 non-financial companies that have reported so far, total net income is actually 13.7% lower than those companies reported in the fourth quarter. A bear would also argue that companies long ago learned that it is better to under promise and over report. Additionally, we went for years with a ratio of positive surprises to disappointments of over 3:1. Therefore, the first quarter surprise ratio of 2.2:1 is not really all that great.

Looking ahead to the second quarter, things don't look too great, with total net income expected to be 36.4% below year ago levels. The only sector that is expected to squeak out a gain over year ago levels in the second quarter is Staples, and that is just 2.2%.

Eight sectors are expected to see total net income at least 25% below year ago levels. (For 5 sectors, the drop is expected to be greater than 40%.)

On a full-year basis, total net income is expected to drop 15.4% on the heels of a 19.3% decline in 2008. However, if the first quarter was down by 31.6%, and the second quarter is expected to be down by 36.2%, then there has to be positive year-over-year growth in the second half to bring the full year back up to just a 15.4% decline. Given the comps, expect that to happen in the fourth quarter.

Scorecard and Median EPS Growth Rates

• Surprise ratio at 2.22 (below normal); median surprise at 4.35% (above normal)
• Median EPS decline reported is 16.9%
• Every sector but Telecom and Health Care was down
• Materials, Energy and Financials post biggest declines in median EPS growth
• Median Decline of 19.3% expected for Q2
• Full year 2009 EPS expected to be down 9.8%, 2010 up 10.2%
• Positive surprises concentrated in the Discretionary, Health Care and Tech sectors

Median EPS year-over-year growth paints a somewhat different picture than does total net income growth. The overall quarterly declines reported are significantly smaller, at 16.8%, and the rankings of the sectors are different. This is most notable in the case of the Financials, where instead of leading, it is near the back of the pack with a 34.6% decline.

Overall we are seeing more than twice as many positive surprises as disappointments, but surprises leading disappointments is normal. However, the size of the median surprise is bigger than normal at 4.35%. That does seem to be a legitimate green shoot.

Overall Tech has the best looking surprise profile, with a ratio of positive surprises to disappointments of 4.6:1 and a median surprise of 8.60%. Consumer Discretionary also looks good with a surprise ratio of 3.1:1 and a huge median surprise of 9.86%. The Financials are the only sector with more disappointments than positive surprises.

The Zacks Revisions Ratio: 2009

• Revisions ratio for full S&P 500 up to 1.09, from 0.92
• One month ago the ratio was 0.65, 2 months ago 0.31, steady and strong improvement
• Five sectors in positive territory, Staples leads
• Now into Neutral territory for the S&P 500 as a whole
• Financials and Industrials continue to see estimates cut
• Ratio of firms with rising to falling mean estimates rises to 0.86 from 0.76
• Total number of revisions (4 week total) down to 3,023 from 4,416 (-31.5%)
• Increases down to 1,576 from 2,119 (-25.6%), cuts down to 1,447 from 2,297 (-37.0%)
• Total Revisions activity has peaked and will plunge over next few weeks

There has been a steady increase in the revisions ratio, which is now up for 10 weeks in a row. Granted it started at absolutely horrific levels, with estimates being cut at more than 4:1 for the S&P 500 as a whole, and in individual sectors, the cuts were often in excess of 10:1.

This week, we finally broke above 1.0, indicating more estimate increases than cuts. Normally that would not be a great cause for celebration, as it really is only a neutral reading. However, when you stop banging your head against the wall, sometimes it feels good. Still there are more S&P 500 firms suffering estimate cuts than increases, but there too, the ratio is much better than it was in the winter or early spring.

Some of the most spectacular changes in analyst opinions have come from the retailers, as the analysts decided that reports of the death of the American consumer were premature. For example, Home Depot (NYSE: HD), Lowe's (NYSE: LOW) and Macy's (NYSE: M) all had at least 10 estimate increases and no cuts, and recorded increases in their mean estimates of 7.3%, 11.4% and 22.3%, respectively. I continue to think that these firms face stiff headwinds from the need of the consumers to rebuild their balance sheets, but it appears that the earlier cuts were over done.

The Zacks Revisions Ratio: 2010

• The overall picture for 2010 similar to that of 2009
• The revisions ratio is up to 0.96 from 0.82
• Telecom and Staples the strongest; Industrials and Financials the weakest for 2010
• Positive surprises leading to more upward revisions
• Ratio of rising to falling mean estimates rises to 0.80 from 0.65
• Total revisions activity has peaked for the quarter
• Total number of revisions falls to 2,264 from 3,332 (-32.1%)
• Estimate increases falls to 1,109 from 1,481 (-25.1%), cuts fall to 1,155 from 1,851 (-37.6%)

As with 2009, the revisions ratio for 2010 has been on a steady rise from abysmal levels a few months ago. While it has not yet passed the 1.0 level it is very close at 0.96.

Earnings Shares and P/Es

• P/Es are too low since earnings estimates are too high
• Health Care expected to take earnings crown from Energy in 2009 and keep it in 2010
• Energy's earnings share expected to plunge to 11.5% from 21.9%
• Financials 2009 earnings share expected to rise to 10.6% from -1.4% in 2008.
• Consumer Discretionary market cap share far above earnings shares (overvalued?)
• Health Care's market cap share well below earnings shares (undervalued?)
• 12-month forward S&P P/E of 14.51 equates to earnings yield of 6.89%, attractive relative to 10-year T-note yield of 3.61%, but is only mediocre relative to 5.95% A-rated 10 year corporate.
• T-note rates are rising and more realistic earnings yields of near 6.06% based on lower earnings ($55) means the spread, while still attractive, is not overwhelming.

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