Earnings Update: Ex-Financials There Are No Upside Revenue Surprises

Much has been said on TV about the "great" earnings season so far. The truth is that ex-financials the upside EPS factor is just 10%. This is driven purely by ongoing cost-cutting and layoffs. What is much more relevant is the top-line. And there again, ex-financials, the upside surprise, is... zero. As David Rosenberg puts it: "In other words, outside of financials, revenues are just meeting analyst expectations. In a nutshell, the impressive earnings surprises, thus far, is being driven by Financials cost surprises (including write offs)." And why are financials beating so heartily? Because they are all reducing loss allowances on their books, when their whole books are based on mark to myth. The wholesale market lie continues, and a read between the lines indicates that the trillions in monetary and fiscal stimulus is still not pushing company top lines. In light of this observation, we are certainly not holding our breaths to see a $100 EPS on the S&P for 2011 as UBS projects.

From David Rosenberg:


Net, net, the situation is still the same for the most part. Earnings surprises are still being driven primarily, though not exclusively, by cost surprises (weren’t CAT revenues down 11% YoY?). The “surprise factor” (the gap between actual and what was estimated going in to the release) for total earnings is 21%, skewed by the 74% surprise factor in the Financials space, excluding Financials, the surprise factor would be around 10%.

The revenue surprise factor is running at a much more modest 3% and excluding Financials (which saw an 8% surprise factor), it would be flat. In other words, outside of financials, revenues are just meeting analyst expectations. In a nutshell, the impressive earnings surprises, thus far, is being driven by Financials cost surprises (including write offs).


Bloomberg News runs with this — U.S. Stocks Cheapest Since 1990 on Analyst Estimates. The article goes on to say that based on the $86 EPS estimate being penned in by the consensus for 2011, this is one cheap stock market. The elite would seem to concur with this notion that with the recession’s ink barely dry and the credit contraction lingering, we are heading back to cyclical peak earnings.

But here’s the rub. Going back over the past 25 years, the consensus has been overly optimistic on earnings 75% of the time and they have missed on a 12-month horizon an average of almost 20%. So the answer is no — the market is more likely trading closer to a 16x P/E than the sub-13x multiple being bandied about by the always rose coloured bulls. On a Shiller trailing P/E basis, the market is trading at 22x. That ain’t no bargain, being six multiple points above the long-run norm.

We are sure to get our share of naysayers emailing us back. Our response, to those who need to be versed in the historical record: Benjamin Graham never ever deployed ‘forward’ earnings as a valuation metric.


  1. Wildly bullish sentiment readings. The latest Investors Intelligence survey is now up to 53.3% for the bulls (versus 51.1% the prior reporting week) while the bear camp has dwindled further, to 17.4% (versus 18.9% a week ago). Bullish sentiment rose for the third consecutive week and bearish sentiment has not been this low since January 12. As Bob Farrell’s Rule number 9 stipulates, when all the forecasts and experts agree, something else is bound to happen.
  2. Uncertainty over the coming U.S. midterm elections in November.
  3. A more hawkish Fed (futures pricing in 40% odds of a rate hike by the November meeting).
  4. Tougher profit comparisons in coming quarters.
  5. The fading of the fiscal and monetary stimulus. The tax credits expire on Friday, the Fed has already stopped buying mortgage bonds and the pace of new trial modifications under the Treasury’s Home Affordable Modification Program has begun to slow.
  6. Fresh uncertainty surrounding banking industry regulation. Goldman is likely the thin edge of the wedge. A proposal is gaining ground on Capitol Hill to force banks to spin off their derivatives-trading operations, which would represent a severe blow to one of Wall Street’s most profitable businesses.
  7. Higher tax rates to pay for the massive $1.4 trillion federal budget deficit. The Bush cuts that lowered taxes on high-wage earners and capital gains and dividends are set to expire at the end of 2010. The top marginal tax rate will jump to 39.6% from 35.0%, and the current 15% rate on capital gains and dividends will go back to 20.0% and 39.6%, respectively.
  8. Huge overhang of unsold houses. As of March, banks and investment trusts had an inventory of about 1.1 million foreclosed homes, up 20% from a year earlier, according to estimates from LPS Applied Analytics. Another 4.8 million mortgage holders were at least 60 days behind on their payments or in the foreclosure process, meaning their homes were well on their way to the inventory pile. That “shadow inventory” was up 30% from a year earlier.
  9. Sovereign debt problems in Greece and spillover to Portugal and possibly Spain.
  10. Ongoing commercial real estate, which have resulted in 55 bank failures this year.
  11. Underfunded state pension plans.
  12. A property bubble in China — the government is now considering introducing new or higher taxes on real estate, possibly a property tax, in order to cool down a booming property market now widely being described as a bubble (prices up well over 10% from a year ago).

Yet in the grand scheme of things, not even these realistic economic observations matter. The outcome will be however Goldman is axed. If Goldman is long (which we doubt due to all the cheerleading by the firm's economic team) we will keep going up. End of debate.