Sunday October 23, 2011

NEW YORK (AP) -- Investors who doubted U.S.companies could make big money in a weak economy have been proved wrong again.

Before companies started reporting earnings two weeks ago, investors worried third-quarter profits might fall short of what Wall Street analysts were predicting. The fear helped push stocks nearly into a bear market. More companies than usual warned the faltering recovery could hurt business.

The reality has turned out different.

Among S&P 500 companies reporting so far, seven out of ten have posted higher profits than expected, called "beats" in Wall Street parlance. For all S&P companies, profits are now on course to rise 14 percent, the eighth quarter in a row they will have grown more than 10 percent. Profits for 2011 are on pace to surpass the annual record set in boom times four years ago.

Stocks have rallied in response. Yet some companies beating expectations are getting punished. On Monday, stock in IBM Corp. fell sharply even after posting better-than-expected profits. And stocks are still priced relatively low compared to earnings.

Part of what’s bothering investors is fear of another economic slowdown. They worry that if Greece defaults on its debt, it could set off another global financial panic and tip the already fragile U.S. economy into recession.


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A recession could mean big trouble for stocks. A year after the last recession started, near-record profits for the S&P 500 turned into losses. The index fell by half, reaching a 12-year low in March 2009.

"People are saying it doesn’t really matter what companies earn if we fall into recession," says Sam Stovall, chief investment strategist at Standard & Poor’s.

Investors are right to worry for another reason: Those corporate "beats" are less impressive than they seem.

Wall Street analysts generally think the U.S. is going to avoid a recession and that stocks are a bargain. Yet they’ve been cutting their estimates in the months leading up to this reporting season, according to John Butters, senior earnings analyst at data provider FactSet.

Which raises the question, Why get excited about a company that beats estimates that have been lowered?

"I’d be more impressed if the numbers hadn’t come down," says Butters, who calculates estimates fell an average 4 percent from this summer through earlier this month. "It’s a solid drop."

Estimates for early next year have been cut even more. Whereas analysts used to expect an 11.9 percent rise in S&P 500 earnings for the first quarter, for instance, they now see them growing 7.7 percent.

Analysts have turned sour mostly on three industries: Financials firms like banks, telecommunication companies and steel and other materials makers. The latter includes Alcoa, which posted profits below estimates that analysts had already cut. For all materials companies, they’ve cut third-quarter estimates 13 percent from the summer through last week.

For all their caution, investors have richly rewarded some companies lately. Shares of Intel Corp. and McDonald’s Corp. rose nearly 4 percent after reporting surprisingly good earnings last week. The S&P index is up 12.7 percent from its low for the year on Oct. 3.

With most companies yet to report, there’s still a chance more could start missing estimates.

On Monday, heavy machinery maker Caterpillar Inc. is expected to report profits per share grew by almost a third over the prior year. Still, the stock has fallen 22 percent in three months as analysts cut estimates. One concern: With economic growth slowing around the world, Caterpillar may have trouble selling tractors and farm equipment abroad.

Package delivery giant United Parcel Service Inc. reports Tuesday. Its stock has dropped more than 5 percent in three months as analysts slashed estimates by a similar amount. Rival FedEx Corp. met expectations when it reported last month. The stock fell to a two-year low anyway, on fears that future earnings might disappoint.

On Thursday, Procter & Gamble Co. will offer insight on consumer spending with its earnings report. In three months, stock in the maker of Pringles and Pampers has risen 2 percent while analysts were cutting estimates 10 percent. In other words, don’t be surprised if the stock drops even if the company beats.

Then again, the report from P&G may get drowned out by other headlines. By then, investors will be digesting details of Europe’s latest plan to shore up its banks and increase the scope of a financial rescue fund. Europe’s leaders hope to hammer out the details at a summit meeting Wednesday.

Depending on how they view the plan, stocks could rise sharply or fall fast. Laments S&P’s Stovall, "The market is driven more by macro news, not micro."

Translation: Profits may not matter as much as you think.