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Colorful first quarter earnings

05/07/2013 @ 9:31am

There are three adjectives that accurately describe first-quarter earnings: "record," "better," and "marginal." The fact that all three can be used illustrates how hard it is to really understand what corporate income statements are telling investors.

First off, this is a record quarter for earnings. Earnings per share for the 500 companies in the index looks like it's going to work out to $26.62 a share last quarter, up from $26.36 in the fourth-quarter 2012 (the previous record), according to S&P Capital IQ.

Earnings were also "better," as in better than Street consensus expectations. The "beat rate," the percentage of companies that are posting numbers better than consensus, is at 69% this quarter, according to S&P. That's above the 62% historical rate.

There are a few outfits that track earnings, and they've all got slightly different numbers. S&P Capital IQ pegs the final first-quarter earnings growth will be 4.8%. Thomson Reuters has it at 5.1%. FactSet has it at 3.2%. None of those are spectacular numbers, but once you start thinking about how they're being produced, they're even less impressive.

For one thing, buybacks are playing a role. As our colleagues Scott Thurm and Serena Ng point out, companies have been accelerating buybacks, which had led to smaller share counts, which has boosted EPS, which has coincidentally boosted CEO pay. The article is about CEO pay, but for the purposes of this post, one tidbit is key: buybacks have boosted EPS. Buybacks accounted for about a fifth of the growth in EPS in 2012, the article states, citing data from David Bianco at Deutsche Bank.

Inflation, of course, plays a role as well. Let's keep it simple and take the most recent CPI report. Prices in April were up about 1.5% in April from a year ago, for all items, not seasonally adjusted. That's not a huge number, to be sure. But figure that into a 5% growth rate, where a fifth of that is also coming from buybacks. What you're left with after taking out those two factors is more or less organic growth, and organic growth is looking mighty marginal.

So, where's the actual, organic growth coming from? Well, it should be coming from sales, of course, and that's the problem. Sales for the S&P 500 companies are seen growing just 1.3%, according to S&P Capital IQ (that, too, is before inflation, incidentally.) To call that marginal is being kind.

The example of McDonald's is instructive; the company is struggling with margins and fixed costs because consumers are pinching pennies even at a fast-food joint. Because of that, the company's keeping prices low in order to lure customers away from competitors. McDonald's is big enough that it can play the pricing game aggressively (Amazon is another one that does this.) But it pays for it on the bottom line.

This isn't a one-quarter phenomenon. Revenue growth has been stagnant for the better part of a year. Sales growth, according to FactSet, was 4% in the fourth-quarter of 2012, it was -0.5% in the third-quarter, it was 0.6% in the second-quarter, it was 5.5% in the first-quarter, and 8.4% in the fourth-quarter of 2011. The third-quarter of 2011 was the last time sales growth was in the double-digit range, as 12%.

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