Most investors have short memories. All you have to do to be smarter than them is to take a longer-term view.
When it comes to short-term thinking, nothing shows it better than earnings season. As you start seeing results for the second quarter come pouring in, keep in mind one fundamental truth: As euphoric as the recovery has been for corporate profits over the past two years, continuing to ramp up earnings will become increasingly difficult for most companies.
The big bounce is done
Two years ago, the financial crisis had put a huge dent into many companies' earnings. The combination of a long, deep recession along with stock market uncertainty created a dour mood for investors.
But last year, all of that started to change. As it became clear that the market meltdown was giving way to a renewed belief in economic recovery, stocks started to rebound. A major part of that rebound came from easy comparisons against prior-year reports. It was easy for shareholders to applaud dramatically higher earnings in 2010 versus 2009 -- regardless of where earnings levels had been before the financial crisis.
As a result, many investors have gotten used to easy comparisons. Unfortunately, all good things must come to an end, and so as this new earnings season begins, you need to be increasingly aware of the potential impact that the new reality for corporate America could have on stock prices.
A look at big winners
To figure out just how big an impact the disappearance of weak year-over-year comparisons might have, I looked at S&P 500 stocks that had the highest earnings-per-share growth rates last year. Most of those stocks, including DuPont (NYSE: DD ) and Qualcomm (Nasdaq: QCOM ) , suffered some pretty big drops in earnings the year before. Yet while investors in most cases aren't having to say goodbye to growth entirely, those incredible growth rates are finally starting to moderate. Consider these companies:
|
Stock
|
EPS Growth Last Year
|
Projected EPS Growth This Quarter (Year-Over-Year)
|
| DuPont |
84.4% |
14.5% |
| Iron Mountain (NYSE: IRM ) |
178.7% |
7.1% |
| Southwestern Energy (NYSE: SWN ) |
1,909.8% |
22.9% |
| Wells Fargo (NYSE: WFC ) |
155.5% |
25.5% |
| Qualcomm |
87.5% |
24.6% |
| Whole Foods (Nasdaq: WFM ) |
86.6% |
23.7% |
Sources: Capital IQ (a division of Standard & Poor's) and Thomson Reuters.
For those stocks that have projections for quarters beyond this one, the future looks even less rosy. By early next year, analysts see Qualcomm's EPS growth approaching the flat line. Wells Fargo's growth is projected to drop to 17% by the third quarter.
Of course, not every stock is doomed to fall back to earth just yet. Unlike many of its fellow high-growth companies, priceline.com (Nasdaq: PCLN ) saw continuing growth even through the financial crisis. Moreover, analysts expect to see almost 58% growth in earnings when it reports early next month.
Stocks have to grow up
Moreover, even the stocks that are seeing their growth rates slow aren't necessarily doomed to failure. Eventually, big companies get to the point where they can't develop enough profitable opportunities to keep generating huge returns on their investment projects. Slowing growth rates inevitably result. The phenomenon definitely isn't unique to this set of stocks.
The key question, though, is whether investors are prepared for that slowdown. DuPont, for instance, trades at around 15 times trailing earnings, which is reasonably close to the market average. Wells Fargo shares fetch an earnings multiple of just 12. But with Whole Foods weighing in at a multiple of 37, investors clearly expect its growth to continue for longer at a more rapid pace.
Be ready
More importantly for longer-term investors, any big stock price hit could give you the opportunity you've been waiting for to pick up shares of promising companies at a bargain. When earnings disappointments hit growth stocks, share prices often tumble sharply -- more than their long-term impact suggests is appropriate. If you're prepared, you can often buy stocks on the cheap in that situation.
Many investors look only at the short term. Long-term investors can profit from them. With patience and vigilance, you can add your name to the latter list of winners.
For some ideas on stocks that are ready to handle tougher comps, check out our free report "5 Stocks The Motley Fool Owns -- And You Should Too." You'll find several stocks that have managed to keep growing even in today's turbulent economy. Click here for instant access to the report.
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