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Earnings Season And the Dow: An Early Look

By Dan Caplinger – Mar 10, 2014 at 12:30PM

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With Nike kicking things off next week, many see the upcoming earnings season as pivotal. Find out why.

Today, the stock market opened lower on fears of global economic sluggishness, with the Dow Jones Industrials (^DJI 0.98%) falling 72 points as of 12:30 p.m. EDT and the S&P 500 declining from Friday's record close. Yet in light of the longer-term trends that helped the Dow's bull market reach the ripe old age of 5 yesterday, many investors are looking forward to the beginning of the first-quarter earnings season for signals about whether the blue-chip index has further to climb in the months and years ahead.

Image Source: Jenni Jones/Flickr.

Will winter ever end?
The main storyline that most investors have followed closely during the first quarter is the impact of harsh winter weather on the economy. Already we've seen countless companies cite weather problems to justify sluggish results, with even major producers citing issues that could hurt first-quarter earnings. For instance, automaker Ford (F 4.83%) said last week that delays in fleet orders due to the winter weather played a sizable role in the company's overall 6% drop in total sales in February from year-ago levels. Many retailers have issued similar warnings, with the latest earnings insight report [opens PDF] from FactSet revealing that 86 companies in the S&P 500 have given negative guidance on first-quarter earnings per share.

On the whole, earnings growth for the first quarter is now seen coming in at just 0.5%, down from expectations of 4.4% at the beginning of the year. Consumer-discretionary stocks such as Ford and General Motors (GM 4.40%) have seen some of the biggest downward revisions, with GM cutting its earnings estimates nearly in half. Among S&P sectors, only utilities have seen higher expected earnings growth, and those stocks obviously aren't included in the Dow Industrials. Yet in the past, a recurring theme has played itself out over and over again: earnings expectations fall in the period leading up to the time at which companies actually start to report results, but then companies are able to beat those modest expectations, sending actual earnings growth higher by the end of earnings season.

From that perspective, the early reporting companies in the Dow will have a lot of insight to give to investors. Nike (NKE 3.64%) reports next week, and investors expect to see a substantial rise in sales accompanied by a slight decline in earnings from year-ago levels. Those results would be very much in line with what retailers reported recently, as heavy promotional activity has hurt margins. Even though Nike's strong brand value should help it maintain revenue growth more easily than some competitors, even the athletic-apparel giant has to deal with shoppers who don't want to venture into the cold.

Bank stocks will also be among the earliest to issue earnings numbers, with JPMorgan Chase (JPM 2.68%) slated to report on April 11. Banks will have lower hurdles to overcome, as investors already expect headwinds from falling levels of mortgage refinancing to have substantial year-over-year impacts on earnings. Yet housing has been relatively resilient so far, raising the hope that new-purchase mortgages can pick up the slack and help boost overall earnings. With financial stocks among the leaders of the latest push up for the Dow, JPMorgan and its peers need to deliver on their promise in order to keep the bull market going.

Are markets too expensive?
The other question earnings season should help answer is whether the Dow has simply risen too far. After such strong gains since 2009, concerns about extreme valuations for stocks have risen to new heights. Yet in driving prices higher, earnings have also posted substantial gains, with forward earnings estimates almost doubling since the 2009 lows. Indeed, FactSet noted that current forward multiples are actually below their 15-year average, albeit with that period including not only inflated late-1990s projections but also the boom markets of the mid-2000s.

Those who would like the 5-year-old bull market to reach its next birthday hope that earnings can keep growing enough to satisfy gun-shy investors who grow more nervous at every new record high. First-quarter earnings season will reveal some useful secrets in determining whether the Dow can keep climbing or whether investors should brace for tough times ahead.

Dan Caplinger owns shares of Ford. The Motley Fool recommends Ford, General Motors, and Nike. The Motley Fool owns shares of Ford, JPMorgan Chase, and Nike. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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