Earnings Season; Top-line or Bottom-line Winning?

I read a FactSet Earnings Insight report last night and it re-affirmed to me my notion that 2014 will be predominantly a stock pickers market. The high flying tech names such as Tesla (TSLA) or Netflix (NFLX) will continue to fly as long as they continue to execute, which in all fairness, they have. However, vis-à-vis the recent economic and earnings data being released, some of the best performing stocks of 2014 will be driven by the value investor. Below is a bullet proof summary of what I found exclusively important from the report. 

• Out of 123 companies that have reported 2013 Q4 earnings, 68% have beaten analyst EPS estimates. This compares to 73% of companies beating estimates over the past 4 years and 71% of companies beating estimates over the past 4 quarters.
•  Thus far into earnings season, aggregate company earnings to beat Wall Street expectations have trended below average.
• Also out of 123 companies, 67% of companies that have reported 2013 Q4 earnings have beaten analyst revenue estimates. This compares to just 59% of companies beating analyst estimates over the past 4 years and 54% beating top-line estimates over the past 4 quarters. 
• Thus far into earnings season, average company revenues to beat analyst expectations have trended above average. 
• The average company to beat analyst EPS expectations has surprised by 2.7%. Over the past 4 years EPS surprises have averaged 5.8%; they have averaged 3.3% over the past year.  
• The average company to beat revenue estimates has surprised by 0.7%. This number is better than the 4 year average of 0.6% and the 1 year average of revenue surprises, which is 0.4%. 

The report accurately notes issues that may have troubled some bottom-line figures such as foreign exchange (FX) rates along with mixed performances in regions such as Europe and China. Many foreign currencies have weakened against the dollar over the past year, in turn shrinking margins for a variety of companies: especially those who rely on the general consumer. I have noticed personally in reports from companies such as Nike (NKE) and Starbucks (SBUX) that FX headwinds have been an issue. Juxtapose this phenomenon with the mixed reaction companies have received in various regions around the world, and we've bean dealt a mixed stream of bottom-line earnings which I expect to continue as companies continue to release 2013 Q4 financial results.

I have held tight to the preconception that top-line revenues will be influential to market sentiment: however as per the above data, is it possible that bottom-line disappointment is aiding the recent sell off? Frankly, who knows? I don't. All I know is that as we move through a period that will likely leave many investors puzzled, I'll be focused on the fundamentals of businesses. I'm looking for strong balance sheets, good value, and as always; a way to make money with defined risk.

Below is a chart of TTM PE values over the past 10 years.

Below are tables detailing 2013 Q4 EPS and revenue growth, segmented by sector.

Sector	Earnings Growth
S&P 500	6.40%
Financials	23.50%
Telecom	16%
Industrials	14.00%
Materials	10.30%
Info. Tech.	5.90%
Consumer Disc.	3.70%
Health Care	3.30%
Consumer Staples	2.50%
Utilities	-5.50%
Energy	-10.90%

                                                                           

Sector	Revenue Growth
S&P 500	0.70%
Info. Tech.	4.40%
Health Care	4.30%
Consumer Disc.	3.20%
Consumer Staples	2.50%
Materials	2.30%
Telecom	2.10%
Utilities	2.10%
Industrials	1.20%
Energy	-1.40%
Financials	-9.90%

Below is a table listing 12-month forward PE ratios, segmented by sector.

Sector	Forward 12-Month PE Ratio
S&P 500	15.1
Consumer Disc.	17.9
Health Care	17.1
Consumer Staples	16.7
Industrials	16.4
Materials	16.1
Utilities	15.3
Info Tech.	14.9
Telecom	13.3
Energy	12.8
Financials	12.6

*All chart and table data provided by www.Factset.com

Choppy Start to 2014 Markets; What gives?

So far, I wouldn’t go as far as saying 2014 market returns have been bizarre, but their performance has been a bit curious to say the least. The end of 2013 saw a market that was able to fight off any bearish sentiment, ending with respective yearly returns of 26.5%, 29.6% and 38.3% in the Dow Jones Industrial Average, S&P 500 and the NASDAQ.  So what gives? Many mainstream money managers claimed January would be an up month, and that gains would continue: yet as we’ve seen that has not been the case. I’ve also listened to and read pieces by money managers who claim we’re due for a healthy correction, but now that the market is trading sideways, say their confused. So again, What gives? Furthermore, if you’ve tuned in to any of the financial networks recently, there is a good chance you’ve heard anchors and contributors speak about the famed 5 day trend; the trend that claims yearly returns tend to correlate with the first 5 trading sessions of the year. If that trend holds in 2014, we're in for quite the reversal compared to 2013. So one last time, WHAT GIVES?

My take is that this sideways performance isn’t all so bad. It’s needed. We haven’t had a meaningful pull-back or correction (5-10%) since 2011, and so eventually profits will be taken, portfolios will be rebalanced, and the markets will face some selling pressure. I’m not necessarily saying this is going to happen tomorrow, but we should at least address the drivers and factors we might encounter before a meaningful sell off: as they could be the same factors currently moving the markets sideways. In this post, I’ll list and briefly explain a bit about those drivers that may be in play currently.

As I mentioned above, the markets SOARED in 2013. So the first driver may be a derivative of that out-performance: where portfolio managers are taking profits, and rebalancing their weightings to sectors that have further growth potential in 2014. That doesn’t sound so unreasonable. Therefore when managers are managing millions or billions in assets, most (but not all) understand they need to put their clients and investors first and actually MAKE THEM SOME MONEY!

FOMC actions are the second driver. The FOMC released its minutes Wednesday which some say influenced a slight dip in the major indices. However, I didn’t find the minutes to be any different than the statement and press conference chairman Bernanke gave in December. They re-iterated; there is no predetermined timeline for future decisions regarding monetary policy; they revealed that all voting members of the committee except for one voted in favor of a reduction in bond purchases; and that a suggestion was made to consider reducing the unemployment threshold to 6% from 6.5%. The above components of the minutes are no different from what we found out in December and so I find it hard to swallow the claim that the minutes caused a fundamental, and not speculative reaction in the markets. None the less, I watched the indices dip quickly on my monitors soon as the report was released: and so regardless of what my personal opinion may be on this specific release, FOMC decisions will continue to affect the markets one way or another. I am under the impression that current uncertainty regarding continued taper decisions may be holding the markets steady.

The third significant driver will be continuously released economic data. This week we’ve seen an ADP employment change measure of 238,000: above a Briefing.com consensus estimate of 203,000 and up from December’s 229,000 measure. We’ve also seen initial claims measurements of 330,000, down from last month’s 345,000 number. Note that with this value, we may still need to account for seasonal unemployment effects, yet I think this measure can be trusted more, relative to December's.  Other measures such as the Michigan Consumer Sentiment Index, the unemployment rate and Non-farm Payrolls will also be closely watched; Investors are still looking to get a better holistic picture of the economy and so tomorrow’s Non-farm payroll and unemployment data will be important.

The last driver I will touch on is this upcoming earnings season. 2013 saw a string of positive earnings releases, however a significant portion of companies grew their net incomes through cost management rather than through revenue growth. This year, investors will be much more sensitive to top line revenues of companies; stocks of companies that grow their top line will outperform those who manage costs to increase their bottom line, in my opinion. As we get ready to kick off a string of earnings releases this month, market participants will be waiting to hear from a variety of management teams before they are ready to put more money to work in the markets, potentially adding pressure to current market levels as well.

As we move through this quarter, the above mentioned factors will remain intact. They may be valid  pressures holding the market in place as we speak; however future turmoil will almost certainly incorporate some, if not all of those factors as well. Below is a 5-day comparative chart of the Dow Jones Industrial Average (green), the S&P 500 (blue) and the Nasdaq 100 (turquoise).