The Alcoa effect: Profits look better

Published: Saturday, January 13, 2007 at 6:01 a.m.
Last Modified: Saturday, January 13, 2007 at 12:30 a.m.
NEW YORK - Advanced Micro Devices Inc. and several other major companies issued warnings this past week that fourth-quarter results will miss expectations. Wall Street barely noticed.
For weeks, analysts have said the long period of stellar earnings growth might be over for U.S. companies, that the 18 straight quarters of double-digit profit growth for Standard & Poor's 500 companies will be replaced by more modest results.
But investors remain upbeat as hundreds of companies are set to report results in the next few weeks. Shareholders did not go screaming for the exits Friday after AMD, business software maker SAP AG and Murphy's Oil Corp. warned results will miss expectations.
In fact, the Dow Jones industrials hit a record close. And analysts say there are signs that companies might have been able to eke out double-digit gains during the last three months of 2006.
''There is an indication that the overall quarter might turn out to be better than expected,'' said David Dropsey, a research analyst with Thomson Financial that tracks equities. ''Earnings are still strong coming out of a lot of sectors.''
For instance, there's an old adage on Wall Street that ''as goes Alcoa, goes the market.'' The world's biggest aluminum maker, which reported its results Wednesday said profits soared 60 percent from a year earlier, and it had a 20 percent jump in revenue that pushed past analysts' expectations.
As of Thursday, 31 S&P 500 components reported earnings. There were 17 companies that beat expectations, six that met them and eight that reported results below projections. That matches the historical averages, Dropsey said.
Of the 31 companies, those that have beaten expectations have done so by an average of 8 percent. This is still well above the norm of a 3 percent rise, according to Thomson Financial. Measuring the pace of profit warnings has also been a good way to judge how the quarter will turn out.
As of Thursday, 156 companies pre-announced results - 37 said they'd be above projections, 26 said they were in line with estimates, and 93 announced they would miss.
Even adding AMD and other recent warnings, Wall Street is still faring slightly better than it did in the third quarter. During that period, 177 pre-announced - 53 said they would beat expectations, 23 said they'd be in line, and 101 said they'd miss.
Although these are extremely early indicators, it suggests the fourth quarter remains on par with the previous quarter. Although many on Wall Street don't expect profit growth to hit the 22 percent level seen in the S&P 500 during the third quarter, it is still expected to blow past the historical average of 7.6 percent.
Portfolio managers say what has come out so far hasn't been significantly negative or positive, and that double-digit growth is still achievable.
''I'd be more concerned if you saw multiple warnings from the same industry,'' said Matt Kelmon, portfolio manager of the Kelmoore Strategy Funds. ''Every quarter for the past 18 quarters we've been waiting for this earnings slowdown, and it's just never come. It might be a headline if it's not double digit, but we're still seeing really strong profits anyway.''
Russ Koesterich, senior portfolio manager at Barclays Global Investments, said investors aren't shaken by the recent warnings. He still sees resilient corporate earnings on the way.
''The expectations for profit growth already were ratcheted down, but we're now seeing some leeway in that,'' he said. ''Even if you have a few of these disappointments like with AMD, that's still not enough to change expectations that profit will decelerate below expectations.''
The S&P 500, considered to be one of the broadest indicators of how the market as a whole is performing, is an index weighted by how many shares are traded in each company. That means the potential for sharp growth in the index as a whole could come from a few key sectors, like financial services stocks, Dropsey said.
Already, major U.S. investment banks and mutual fund companies that reported in December have shown record-breaking results. Property and casualty insurers might also surprise Wall Street because of the quiet hurricane period this year.
There's even the possibility of decent earnings coming from the nation's biggest automakers. General Motors Corp. and Ford Motor Co. - both big members of the index - could post stronger-than-expected results considering recent restructurings.
''These areas have the potential for surprise,'' Dropsey said.

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