Wall Street analysts are "already throwing in the towel" on 3Q, 4Q revenue growth with forecasts for the 30 Dow Jones Industrial Avg. companies of 2.5%, 1.6% versus predictions of 3% or more just 2 months ago. ConvergEx's chief market strategist Nicholas Colas explains these lowered forecasts fly "in the face of a general consensus from the economic community, the Federal Reserve included, that the back half of 2014 will be better than the Polar Vortex-damaged first half of the year." As Colas warns, rather ominously, "we aren’t pricing 1.6% revenue growth for Q4 2014 with price/earnings multiples at 17-18x. If you are buying Dow 17,000 or S&P 1980, you expect better. Now, companies and the macro economy have to deliver."
Via ConvergEx's Nick Colas,
With U.S. corporate earnings season in full swing, today we look at what analysts expect for revenue growth over this and coming quarters. It’s a good news/bad news thing. For Q2 2014 – the quarter we’re seeing reported right now – analysts forecast an average of 1.7% year-over-year sales growth for the 30 companies of the Dow Jones Industrial Average. That’s a muted golf clap better than the 0.3% actual from Q1 2014. At the same time, consider that just 6 months ago analysts were expecting Q2 2014 to print +3% in sales growth. The next few quarters show the same trend – Q3 2014’s current 2.5% expected revenue comp used to be 5%, and the 1.6% analysts have in their models for Q4 2014 started life at 3%. Revenue estimates are clearly still coming down, which raises a key question: “When will we get a positive surprise?” Since markets typically discount events 2 quarters ahead, the continued rally in equities points to that low-bar 1.6% Q4 2014 expectation. Christmas in July?… Let’s hope so.
My doctor is fond of an old Yiddish saying: “Man plans and God laughs”. It’s not what you’d expect to hear from a medical man, but he is also free with the more standard advice. “Eat better, exercise more...” At the same time it is heartening that he understands and embraces the role fate plays in life. Either that, or he has given up on me. It might be that.
As a sell side analyst for a decade, as well as investor and strategist for another +10 years, I appreciate the aphorism from another perspective as well. I have had to do more earnings models in my career than most people reading this note. While all the inputs and subcategories and marginal calculations may look impressive, financial models are just another version of “Man plans”. Sometimes it works, and sometimes it doesn’t. God laughs.
Earnings models are the most misunderstood tool of financial analysis on Wall Street, if you want to know the plain truth. Yes, it is always gratifying to “Get the number right”, but that’s just a piece of the puzzle. A good model reveals far more about the long term health of a business than just hitting the EPS number lottery might indicate. Here are some other bits that actually matter just as much, if not more:
Cash generation. The typical income statement has large non-cash charges like depreciation, amortization and taxes. It also ignores capital expenditures, acquisitions, and working capital requirements. Health may be wealth (yep, another one from my doc), but cash also counts. The value of a business is its cash flows, real or projected. Earnings are sometimes a reasonable proxy, yes, but you have to tie them to cash flow to make a valid investment case.
Margin analysis. Spoiler alert: this is where the magic actually happens in a good financial model. What incremental profit does the “nth” unit of revenue carry? If it is a fully loaded pickup truck rolling down the line at an auto assembly plant, the answer might be 80% incremental profit to the car company producing it. And if it is a low end flat screen TV moving through a plant in eastern China, then 5% to the maker might be right. Or zero. Big difference, and good margin analysis captures that.
Revenue growth. In the end, everything in an income statement flows from the top line, and the critical components here are units, price, and mix. Those inputs all flow from the success of the company’s strategy, not from cells A5 to J22 on an Excel spreadsheet. A company with an expanding competitive advantage always has better sales growth than its peers. As the old football saying goes, “You are what your record says you are”. You can muck around with accruals to “Make” an earnings number, but revenues are far harder to fake or fudge.
With that all in mind, it should be no surprise that for the last 4+ years we’ve tracked the projected revenues for each of the 30 companies in the Dow Jones Industrial Average. By looking at the revenue growth that brokerage analysts show the investment world every month, we track the confidence they have in future top line growth. And since we are talking about dominant multi-national companies, these expectations are reasonable proxies for macroeconomic growth as well as single-stock or sector fundamental strength.
The charts above show the slide; but here is a brief summary of this month’s findings:
Analysts have never been more bearish on Q2 2014 as they are right now. This is the quarter we’re hearing about this month as companies report, and Wall Street isn’t expecting big things. The average expected revenue growth for the 30 companies of the Dow is just 1.7%, and 2.0% excluding financial companies. This is better than the 0.3% actual comparison between Q1 2014 and Q1 2013, so the optimist would say “Accelerating comps!” The realist would quickly point to the steady decline in expectations for Q2 2014 and wonder if companies can meet even this reduced set of expectations. After all, at the end of 2013 the analyst community was looking for 3-4% year on year revenue growth. Now, they hope for half that. Man plans…
Looking towards the back half of 2014, and analysts are already throwing in the towel on revenue growth even reaching 3%. For Q3 2014, the current estimate is 2.5% year on year sales growth. For Q4, that number is just 1.6%. Both were higher just 2-3 months ago, at 3% or higher. That comes in the face of a general consensus from the economic community – the Federal Reserve included – that the back half of 2014 will be better than the Polar Vortex-damaged first half of the year.
Frequent readers of this note will know that analysts always, always, always guess high and then slowly bring their numbers lower over the course of the year. This is because it is easier to explain higher earnings in the context of an expanding economy rather than an ever-more-brutally efficient cost structure. It also nets a higher valuation multiple, of course. So what’s really new here?
The answer is on your screen every day. U.S. stocks are trending higher (large caps, anyway… the types of names in the Dow). How do we square that with relatively high valuations and sparse revenue growth? There is only one answer that makes sense: markets expect that Q4 2014 will surprise to the upside versus that paltry 1.6% expected revenue growth print. The U.S. economy will actually grow at a 2-3% pace in the back half of 2014, and corporate revenues and earnings can actually surprise to the upside.
For those investors and commentators waiting on a “Correction”, here is the Achilles heel that will cause markets to stumble. The current earnings season, and the hundreds of conference calls that it spawns, must give analysts some reason for optimism about revenue growth. We aren’t pricing 1.6% revenue growth for Q4 2014 with price/earnings multiples at 17-18x. If you are buying Dow 17,000 or S&P 1980, you expect better. Now, companies and the macro economy have to deliver.
But remember, “Man plans…”