These 7 Turnaround Stocks Will Trick You

In case you haven't heard, economists have said that the recession is probably over. In response, the stock market has started partying like it's 1999 all over again.

But before you break out the champagne and set aside all the cynicism about whether lasting economic growth is back, keep this in mind: You're going to hear a lot in the next year about companies posting higher earnings, but take it all with a big grain of salt. Putting what may look like booming earnings into a longer-term perspective will give you a much more sober assessment of all the damage that has been done during the bear market.

Why earnings comparisons lie
By their nature, earnings reports are focused on the short term. They give information about three months of financial results, and most investors only pay attention to how those numbers compare with the same quarter from the previous year.

What that means is that if a company has a particularly bad quarter one year -- as many companies did in late 2008 and early 2009 -- its stock may suffer at that point. But when the next year rolls around, even a modest recovery back toward more normal levels will look like significant growth.

As an example, take a look at these figures from Standard & Poor's, detailing actual reported total quarterly earnings for the stocks in the S&P 500.

S&P 500 aggregate earnings:

You can see the ongoing downward trend during the recession, with particularly bad earnings in financial and consumer discretionary stocks leading the way down. But when you compare the latest quarter's estimates -- since we're still in the middle of earnings season -- with results from the second quarter of 2008, you can see something we haven't seen in a while: a year-over-year rise in earnings.

That sounds great and makes for good headlines. But don't expect the stock market to hit new records anytime soon, because earnings still have a long way to go to recover fully.

Don't trust those comps
From one perspective, signs of a bottoming economy show that recovery may be right around the corner. But if you only look at earnings over a one-year period, you might get lulled into a false sense of security.

For instance, look at these companies:

Source: Yahoo! Finance and Capital IQ, a division of Standard and Poor's.

I'd bet that if JPMorgan Chase meets earnings expectations next quarter, you'll read all about how the company quadrupled its earnings per share from last year. What you won't hear, is that those earnings will still be less than half what they were in 2007.

Why it matters
And unfortunately, it's those 2007 numbers that are more important in determining whether the stock market can claw its way back up to its record highs. Even with higher earnings two years ago, no one was claiming that the market's valuation was cheap back then. If it takes a few years for companies to reclaim all the ground they lost during the recession, investors looking to reopen the record books will have a long wait.

The fact that the economy may be bottoming is definitely good news for everyone. But don't let that fact give you a false sense of euphoria. It's going to take time before companies see their financial results recover their former glory.

Do you think the economy is really recovering? Tell me about it in the comments section below.

Paul Elliott thinks you're looking in the wrong place to find tomorrow's winners, but he'll get you pointed in the right direction.