With one week to go to the start of earnings season, there's been little in the way of high-profile earnings guidance. What's up? It's pretty simple: either CEOs are happy with the guidance they have given — or we've got some surprises coming. ?
Are CEOs happy with their guidance? I've noted for two months that the main story of the quarter will likely be margin compression on higher commodity costs.
This is not welcome news: one of the big factors in earnings growth last year was margin expansion on outstanding cost control. How great were margins? Analyst Ned Davis has noted that S&P 500 margins, at 8.2 percent, are only 41 basis points below their July 2007 all-time highs. Davis believes that "Most of the earnings gains from margin expansion are likely over."
Uh-oh: that means we better starting getting more topline growth to drive earnings. Indeed, analysts seem to be betting on this, relying on 14.2 percent sales growth for 2011, according to Standard & Poor's. Is that a little, or a lot?
It's a lot, according to Davis: "There isn't much historical precedent for 14% y/y sales growth."
So if we are peaking with margin expansion, and possibly peaking on sales growth, what's left to drive earnings? Massive buybacks? Net purchases of stock by companies amounted to 3.4 percent of market cap last year, according to Davis, a respectable number that has undoubtedly helped earnings. But even assuming that continues this year, that alone is not going to get us to earnings growth-land.
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