Wall Street's best-kept secret may be earnings growth

Investors can't blame the stock market's bumpy ride so far this year on S&P 500 earnings, which could end the reporting period with the best quarterly growth in more than two years.

Results haven't done much to prop up the overall market, but analysts said that the numbers should relieve worries that last year's big rally came without much gain in profit growth.

Investors turned their focus in recent weeks to volatile emerging markets and less stimulus from the Federal Reserve. At the same time, fourth-quarter earnings growth has clocked in at 9.5 per cent above year-ago results, better than the 7.6 per cent expected when the period began.

Notably, companies that surprised investors with better-than-expected results in terms of both revenue and profits reaped a reward: Their stock prices jumped.

On average, those that beat on both metrics are up 2.1 per cent in the five days that followed their results, according to Bank of America Merrill Lynch research, while those that missed on both are down 5.6 per cent in that time. That gulf is the biggest seen since the fourth quarter of 2008.

Consumer discretionary stocks had the biggest gap between the gainers like Netflix Inc, which rose 20 per cent in the five days following its results, and losers like Amazon.com Inc, which fell 12 per cent in a similar period.

In all, 68 per cent of S&P 500 companies' results are beating analysts' expectations on earnings, above the 63 per cent long-term average, while 66 per cent are exceeding forecasts on revenue, which would be the best "beat rate" since the second quarter of 2011, Thomson Reuters data showed.

"The percentage of companies beating on EPS, on sales and on EPS and sales - all of those metrics - are above average. That's a pretty positive sign," said Dan Suzuki, US equity strategist at Bank of America Merrill Lynch in New York.

If the pattern of big swings for consumer discretionary companies' stocks holds, it implies more volatility for those that have not yet reported, including Kohl's Corp, Gap Inc and Lowe's Companies, Inc , as well as other retailers that struggled through the most competitive holiday shopping season for the U.S. industry since the recession.

Solid results, even if overlooked

With results in from about 70 per cent of S&P 500 companies, the group is on track for the best earnings growth since the third quarter of 2011, Thomson Reuters data showed.

Revenue growth at 1.1 per cent is still expected to lag the third quarter, but the percentage of companies beating analysts' forecasts is the best in more than two years.

Those are sound results for a stock market that has been turbulent this year, with the Standard & Poor's 500 index posting a 3.6 per cent loss in January and slipping 1.6 per cent so far in 2014.

That downturn follows the S&P 500's 30 per cent gain last year, when earnings rose just 6.1 per cent. Valuations increased sharply because of the price gains, with the S&P 500's forward four-quarter price-to-earnings ratio now at 15.1, compared with 13.1 at the start of 2013, according to Thomson Reuters data.

"A lot of people have begun to wonder about the sustainability of the rally because it was driven so much by multiple expansion rather than earnings, and that's entirely accurate," said Dan Greenhaus, chief strategist at BTIG LLC in New York.

But "earnings are going up - earnings are accelerating," he said.

Many investors were expecting profit growth to pick up in 2014, thanks to a more robust U.S. economy, with double-digit earnings growth projected for the third and fourth quarters.

On some levels, earnings have done well once again by exceeding expectations. Outlooks for the fourth quarter were the most negative of any period since at least 1996, when Thomson Reuters began tracking this data.

The earnings season, to some degree, has been overshadowed by the rout in emerging markets, which prompted a selloff in stocks in the United States and other developed economies.

Financials have had the most positive earnings surprises, with results from insurers like the Travelers Companies, Inc and Allstate Corp among those in that sector that have beaten expectations by the biggest margins.

Not everything is picking up.

Outlooks for the first quarter remain largely negative, with 4.8 companies warning for every one with a positive forecast, Thomson Reuters data showed.

Earnings estimates for all of 2014 have slipped, with growth now predicted at 9.3 per cent versus a January 1 forecast of 10.8 per cent.

Copyright: Thomson Reuters 2014