EarningsCenter

The Trouble With Earnings: Good Profits, Bad Revenues


By MATTHEW CRAFT

Procter & Gamble had been on a tear.

The company's stock had climbed 22 percent since the start of the year as the maker of Tide detergent and Crest toothpaste turned in better profits for two quarters in a row. Last Thursday, P&G reported even higher earnings. And its stock immediately dropped 6 percent.

What happened? Like so many other big companies reporting results recently, P&G hit its target for earnings but missed on revenue. Nearly halfway through the first-quarter earnings season, Corporate America is still reporting solid profits, with seven of every ten big companies hurdling over Wall Street's expectations. Sales, however, are another story.

Nearly the same proportion of big companies - six out of ten - have fallen short of revenue targets, according to S&P Capital IQ. The tally so far looks grim: Revenue has shrunk 2.4 percent compared with last year.

"The norm is becoming, beat your earnings, but miss on revenue," says Scott Freeze, president of Street One Financial.

Two problems persist: Europe's ongoing recession and slower economic growth in China. Because nearly half of revenue for Standard & Poor's 500 companies comes from abroad, it would seem logical to think the problem is just overseas. But many companies with a U.S. focus have also reported disappointing revenue.

Freeze says that revenue presents a more accurate picture of Corporate America's health. "You can play with the earnings numbers and have them skewed," he says. "But you can't mess with the revenue numbers - they are what they are. If people are not coming in droves to buy your products, your revenue's going to miss even if your earnings beat."

Aside from Apple's falling profit and some other high-profile flops, the headline numbers for first-quarter earnings appear solid. So far, 271 companies in the S&P 500 have said earnings are up 5 percent over the year before. And 189 of them have cleared Wall Street's estimates.

Investors say that's no surprise. They believe companies set the bar so low that it's easy to jump over it. The 3.6 percent earnings growth analysts expect to see after all the results are tallied works out to $26.36. That's just $1 more than the same period last year.

As one company after another turned in weak revenue results last week, analysts, investors and economists started raising concerns about the prospect for future profits.

Some of the biggest names in Corporate America have disappointed, including Google, JP Morgan Chase and IBM, which posted its first drop in revenue in three years. In the past week, AT&T, Xerox and Safeway joined their ranks.

Of the 22 corporate giants in the Dow Jones industrial average that have reported results, 15 have missed their revenue targets, according to the data provider FactSet.

If the trend continues, experts see a number of consequences:

- Earnings estimates for the coming months will have to come down. Revenues drive profits. And if revenues start to sag, it's going to be difficult for companies in the S&P 500 to have average earnings growth of 8 percent for the rest of the year, which is what analysts currently expect.

- To maintain their profit margins, companies will look for ways to trim expenses even more. That often means cutting jobs or scaling back spending. Earlier this month, for instance, Caterpillar announced plans to lay off workers in Milwaukee, Decatur, Ill. and Brussels. The reason? Sales of Caterpillar's large trucks and bulldozers had slumped.

- If either earnings estimates come down or layoffs pick up, it could easily upend the stock market's four-year surge.

To be sure, many of the companies missing their revenue targets are grappling with their own unique problems, says John Butters, senior earnings analyst at FactSet. AT&T reported that fewer people signed up for phone plans. Boeing delivered just one 787 before the planes were grounded in January because of overheating batteries.

But the recurring theme is weak demand, says Tom Porcelli, chief U.S. economist at RBC Capital Markets. Businesses and individuals just aren't spending enough to push sales up quarter after quarter.

"The economic backdrop remains sluggish," he says. "It's really as simple as that."

In the U.S., recent reports showing sagging retail sales and a slump in business orders for big-ticket items have raised concerns about a slowdown. But it's a worldwide trend, Porcelli says.

Economists like Porcelli check surveys to see if manufacturers around the world are ramping up or slowing down production. As of last week, fewer than a fifth of the 34 developed countries reported more activity, down from a third at the start of the year. Back in 2011, three-quarters of these countries said production was picking up.

To keep profits rising, companies have been cutting costs to compensate for tepid sales. They have delayed plans to replace equipment, laid off workers and been slow to hire them back when things look better. In short, Corporate America and the people they employ are top notch at doing more with less.

During earnings calls this month, five of the country's biggest banks revealed that they have slashed more than 31,000 jobs over the past year. That's 3.5 percent of their combined workforce. JPMorgan plans to lay off even more, aiming to cut nearly 7 percent of its employees over the next two years.

It's a "perfectly sensible reaction" when sales results prove disappointing, Porcelli says.

The problem is that cost-cutting has its limits. U.S. companies already run more efficiently than they once did. They squeeze 9 cents of profit out of every dollar of revenue, compared with an average closer to 7 cents since 1979, according to Goldman Sachs research. Analysts expect this profit margin to reach 9.8 cents next year.

Jeffrey Kleintop, the chief market strategist at LPL Financial, is skeptical that companies will be able to shed enough expenses to hit their earnings targets. "When there's no more fat to cut," he says, "you start to cut muscle, and then you're cutting bone."

In a strong economy, a single company can support its profits through payroll cuts. It's another story entirely when, in a choppy economy, scores of big companies decide to make the same move. Even delaying hiring plans can backfire.

"It's a conundrum," Kleintop says. "Businesses say they're not going to hire until they see better growth, but there's not going to be better growth until there's more income and hiring."

After all, one company's employee is another company's customer.

___

AP Business Writer Christina Rexrode contributed to this report.

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warren

It all revert to the one unbreakable law of supply and demand. If wages do not rise to meet the demand then revenue will fall. To have demand you must have the disposable income to satisfy that demand. Yes you can raise prices and cut costs to increase earnings but there is always that tipping point where if people do not have the income then supply will fall and asset values will follow. Commonsense is such an easy thing to lose in statistics. You can manipulate the law as long as you want but in the end it will always be true. 50% of the American population only reported 12% of the total AGI to the IRS. Supply and demand.

April 29 2013 at 9:54 AM Report abuse rate up rate down Reply
shalebrook

The earnings of most major companies today ois generated by the efficiency gained when they cut jobs in 2008-2009 and are failing to rehire full time employees due to Obamacare fears. In a very real sense, the short term stock performance of Wall Street right now is the very opposite of what is going on in the economy in general.

Look at employment:

1. 2008 black unemployment at 10%. today 14%. Food stamps, welfare and disability all sykyrocketing.

2. The Government's onw Labor participation rate shows that fewer Americans able to work are actually in the work force than at any poreviosu time since 1979-during the Jimmy Carter Stagflation era. Bush jr left us with a 65.8% labor participation rate. but under Obama it is 63.3% ar present-a 2.5% drop.


Watch out for 2014 ewhen the full economic impact of Obamacare takes place-the cost of the program to the average family scheduled to rise by $2,500 per year-rather than drop $2,500 as promised by Obama. And the suppression of job creation by the private sector caused by the fear of the great cost of Obamacarewill continue to hold the jobs market way down.


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April 29 2013 at 9:12 AM Report abuse rate up rate down Reply
dibeem

its kind of hard to buy wants when most of us "middle class" cant even afford the needs

April 29 2013 at 8:45 AM Report abuse rate up rate down Reply