Don't
Fall For The Profit Hype
By Richard Moroney, editor
Dow Theory Forecasts
After
falling 29% last year, earnings for companies in the S&P1500
SuperComposite Index, a mix of large, midsize, and small stocks,
are expected to increase 31% this year and another 19% in 2003.
Investors looking at year-ahead performance might find that growth
impressive, and with good reason. But a quick peek in the rear-view
mirror can help avert the kind of accidents that crushed portfolios
in 2001.
Assuming projections
prove true, S&P 1500 earnings will post annualized growth
of about 3% between 2000 and 2003, which is nothing to brag about.
All but three of the 10 industry sectors in the index posted
profit declines in 2001, and abnormally low profits last year
could pave the way for large percentage gains this year. Even
after these gains, all but four sectors are expected to generate
2002 profits lower than 2000 numbers. Only three sectors consumer
staples, financial services, and health care are expected to
enjoy three-year annualized profit growth of more than 7% through
2003.
The numbers don't lie,
but they do conceal part of the truth.
First of all, they
overstate capital gains potential. The consensus estimates of
57% profit growth for companies in the consumer discretionary
sector and 52% for telecommunications providers this year take
into account many companies that lost money last year and expect
to turn a profit this year. The consumer discretionary sector
lost 8% of its value during the first six months of this year,
while the telecom sector plunged 36%. Stock prices eventually
follow earnings, but expecting stock gains of even half of the
projected profit increases is wishful thinking.
Second, many of the
estimates sound overly optimistic. The economy is recovering
slowly, and a stream of corporate scandals is not helping matters.
Earnings estimates have been dropping in recent months, yet the
consensus profit estimates for the S&P 1500 still project
more than 40% growth in the September and December quarters targets
that sound too aggressive even considering easy comparisons to
weak 2001 performance.
So what should you
do? Rather than concentrating on the market as a whole, or even
on sectors, consider individual stocks. All of the companies
discussed below are rated Buy or Long-Term Buy and are in sectors
in which three-year profit growth should be positive.
Consumer Staples
Kimberly-Clark
(NYSE KMB $56) said June-quarter revenue, keyed by higher
sales volumes of consumer tissue and personal care products,
rose 5% to $3.4 billion. Price cutting and higher competitor
promotional activity reduced revenue slightly. Consumer tissue
sales jumped nearly 10%, with increases in every market. Excluding
unusual one-time items, earnings were $0.86 per share, versus
$0.81 in 2001. Kimberly-Clark is pumping out plenty of cash.
The company said its free cash flow cash from operations minus
capital expenditures and dividends was $633 million in the first
six months about four times the amount in the first half of 2001.
The stock is rated Long-Term Buy.
PepsiCo
(NYSE PEP $36) earned $0.52 per share in the June quarter,
up 14% from 2001. Sales, which rose 2% to $6.2 billion, trailed
volume growth because of foreign currency impact. Total volume
increased less than expected because of a 3% decline in Tropicana
volume and weak demand in Latin American markets and the Middle
East. Volume at Frito-Lay jumped 5%, driven by higher-priced
new products. PepsiCo reiterated its target earnings-per-share
growth for 2002 of 13% to 14%, roughly in line with current Wall
Street estimates of $1.95 a share. The company also announced
a new $5 billion stock-repurchase program for the next three
years. The shares retreated on the weak sales results, but
the company's long-term growth story remains intact. PepsiCo
is a Focus List Buy.
Tobacco giant Philip
Morris (NYSE MO $44) said higher cigarette prices and strong
international sales keyed June-quarter growth. Earnings rose
12% to $1.24 per share. Underlying sales inched up 1% to $21.1
billion. But excluding currency adjustments, revenue increased
nearly 3%. As expected, U.S. cigarette shipments dipped during
the quarter, hurt by wholesalers stocking up during the first
quarter to avoid tax and price increases. Philip Morris plans
to invest some $350 million in its premium brands. The move will
depress profit growth in the near-term. The company now expects
profit growth for 2002 to be at the lower end of its guidance
of 9% to 11%. Philip Morris is rated Buy.
Financials
Astoria
Financial (NYSE AF $28) reported June-quarter earnings of
$0.73 per share, up 24% from 2001. Excluding the impact of goodwill
amortization, core earnings improved by 14%. Solid loan growth,
strong margin expansion, and lower shares outstanding drove profit
growth. Total loans increased to $12.5 billion, up $864 million,
or 7%, from a year earlier. Astoria specializes in single-family
residential mortgage lending. Since September, the company has
repurchased 5.7 million shares of 10 million shares it is authorized
to buy. Looking forward, healthy loan growth and ongoing share
repurchases should bolster per-share profits. The stock is
rated Buy.
Golden West Financial
(NYSE GDW $58) earned $1.44 per share in the June-quarter,
compared to $1.30 a year earlier, beating the consensus estimate
of $1.41. The company focuses on adjustable-rate mortgages. Loan
originations were a record $6.9 billion, up 23% from 2001 despite
an environment that favored fixed-rate mortgages. Low interest
rates and a stable housing market should continue to support
solid loan growth in the coming quarters. Golden West's finances
are rock solid, and the company has maintained its premier credit
quality. Golden West is a Focus List Buy.
Synovus Financial
(NYSE SNV $21) said June-quarter earnings were $0.29 per
share, up 12% from last year. The bank, which boasts an 81% ownership
of Total System Services, one of the largest credit card processing
companies, expects to hit its aggressive earnings-growth targets.
The company projects at least 15% profit growth in 2002 and 15%
to 18% growth in 2003. The stock typically trades at a premium
price/earnings multiple because of its steady bank results and
strong processing business. But the shares seem reasonably valued
at around 17 times 2002 per-share estimates. The stock is
rated Buy.
Health Care
Baxter
International (NYSE BAX $32) was hammered after reporting
June-quarter profits that matched Wall Street estimates but sales
that fell short of expectations. Earnings were $0.32 per share,
compared to $0.42 a year earlier. Excluding one-time charges,
earnings were $0.48 per share. Revenue rose 8% to $2 billion.
Excluding the impact of foreign currencies, sales would have
increased 9%. Some analysts said sales missed their target by
as much as $100 million. Investors appear to have overreacted
to the sales shortfall. The company stuck with its previous guidance
for sales growth in the low teens and earnings growth in the
midteens. Sales are expected to accelerate, partly thanks to
strong demand for drug delivery and anesthesia products. Baxter
is rated Long-Term Buy.
Health Management
Associates (NYSE HMA $17) matched the consensus estimate
with profits of $0.26 per share in the June quarter, up 24% from
a year earlier. Sales jumped 25% to $593 million. Net patient
service revenue at hospitals owned and operated for at least
one year rose 8% the top end of the company's target range. Same-hospital
sales have increased for 55 straight quarters. During the quarter,
the company acquired its fifth hospital of fiscal 2002 ending
September. Robust sales growth and cost controls should fuel
profit gains. For fiscal 2002, earnings are expected to climb
21% to $0.97 per share. For 2003, per-share earnings should reach
$1.12. The stock is rated Long-Term Buy.
Merck (NYSE
MRK $39) reported June-quarter earnings of $0.77 per share, compared
to $0.78 a year earlier. Sales rose about 8% to $12.8 billion.
Merck's five major products osteoporosis drug Fosamax, arthritis
drug Vioxx, cholesterol drug Zocor, blood-pressure medications
Cozaar/Hyzaar, and asthma drug Singulair notched an overall sales
increase of 14% during the quarter. Profits were hurt by higher
material and production costs at the company's Medco unit. Merck
remains committed to spinning off the business over the next
year. The company expects earnings to be $0.81 to $0.85 in the
September quarter. Full-year earnings should be flat with 2001,
when Merck posted earnings of $3.14 a share. The stock is
rated Long-Term Buy.
Editor's Note: Richard
Moroney is editor of Dow Theory Forecasts, 7412 Calumet
Ave., Hammond, IN 46324, 1 year, 52 issues, $259. Visit the web
site at www.dowtheory.com.
