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US: Third quarter earnings season starts with a bang!
October 16, 2009

Third quarter earnings season has kicked off in the US, with Alcoa thrashing market expectations by reporting a small profit. Is this a harbinger of better things to come?

Author : iFAST Research Team

Untitled Document
Chart 1: US COnsumer credit
Chart 2: S&P 500 earnings, revenue and estimates
Key Points
  • US companies have begun to report their third quarter earnings
  • Cost-cutting may allow earnings to continue to surprise on the upside in 3Q 09
  • More attention expected to be paid to a recovery in sales
  • Earnings season is expected to provide insight on various aspects like a recovery in demand or the extent and effects of cost-cutting
  • However, it is less important to focus on one quarterly data point
  • Look towards 2010 and 2011 earnings instead

Alcoa kicked off earnings reporting season for the third quarter of 2009 with a huge positive surprise, reporting earnings per share of US$0.04, versus a net loss forecasted by the consensus. The company, a component stock of the Dow Jones Industrials Average, had been hit by a slump in demand for aluminum and recorded three consecutive quarterly losses before the current third quarter earnings report.

Cost-cutting boosted earnings in 2Q 09

Other than the increases in aluminum prices, Alcoa also attributed cost-cutting measures as a key reason for the return to profitability. Like Alcoa, most US companies have undergone massive restructuring and employed various cost-cutting measures, which has boosted bottom-lines in the second quarter of 2009. While this has led to a flurry of better-than-expected earnings in 2Q 09, many sceptics claim that these measures will only work in the short run, whereas actual demand has not returned and will hurt profit growth in subsequent quarters to come.

A recovery in sales?

A single data point, nothing more

Some investors will approach this period with huge anticipation, passing each day with much anxiety as companies progressively report their earnings for the third quarter of 2009. We do admit that less positive earnings may result in a market dip, but the converse is also true: if earnings exceed expectations the market may continue its ascent. Earnings reports (whether positive or negative) will drive the stock market in the near term, but attempts to second-guess a positive or negative result for any one company and timing one’s entry or exit in the market will likely be a futile exercise.

While this quarterly earnings season will provide insight into various aspects like the strength of a recovery in demand or the extent of cost-cutting and restructuring measures, we do not encourage too much emphasis placed on this single data point in stock markets. Quarterly earnings are often fraught with uncertainty, especially coming out of a recovery. Investors who take a longer-term view should be looking at expected 2010 and 2011 earnings to reap rewards further down the road as a recovery in the US economy unfolds. As at 7 October 2009, the US market trades at PE ratios of just 14X and 11.5X based on 2010 and 2011 earnings respectively.  

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