First-quarter earnings season is coming to a close, with 24 out of the 30 companies in the Dow Jones Industrials (^DJI -0.11%) having reported results. Yet with further signs of weakness on the earnings front, can the Dow's bull market really post a sixth straight year of gains, or will expectations for a much faster gain in earnings growth from IBM (IBM 1.05%), Microsoft (MSFT 0.37%), and other important Dow components help push the average higher still even from near-record levels? Given the Dow's sustained gains in April despite a relatively poor earnings season, it looks like investors believe the bull market still has room to run and that a long-awaited bearish correction could stay away a while longer.
Source: Jean-Pierre Lavoie.
Evaluating the Dow's earnings season
FactSet Research recently took a look at how the Dow has fared during this earnings season. With 80% of the Dow's members having reported first-quarter earnings, expectations are that the Dow will end up having seen overall earnings decline by 3.3% from year-ago levels. As FactSet points out, this would be the third time that the Dow has had year-over-year declines in earnings growth in the past four quarters, which you'd ordinarily think would be grounds for at least a market correction. Moreover, revenue growth has been sluggish, with projections for just the slightest growth of 0.4% -- escaping a fourth quarter of declining sales out of the past five, but still showing the extent to which companies are struggling to grow.
Yet the Dow climbed to new record highs last week. One explanation is that many analysts see earnings and revenue growth finally accelerating later this year to make up for the recent doldrums. For instance, Microsoft earnings fell 6% in the latest quarter on a GAAP basis compared to last year's quarter, and they're expected to drop again this quarter. But in the second half of the calendar year, Microsoft should finally start to pick up steam on the earnings front, with about a 7% year-over-year earnings gain expected for fiscal 2015. Similarly, IBM earnings dropped 21% during the first quarter, but analysts now expect a rebound as soon as this quarter, with projections of 34% earnings growth in the current quarter.
There are reasons for optimism among Dow investors. For instance, with these two companies, Microsoft has started coming up with new and innovative ways to try to capture various segments of the technology industry that it hasn't always gone after aggressively in the past. With newfound confidence in its corporate leadership, Microsoft could finally break out of the inferiority complex that has plagued it since the turn of the millennium. Similarly, IBM has faced huge competition from other tech giants trying to capitalize on big-picture ideas like the Internet of Things and data analytics, but it has also identified ways to differentiate itself from the pack.
A rebound in earnings of the magnitude that many investors expect is far from a sure thing, but it's also not impossible. What investors in the Dow Jones Industrials should remember going forward, though, is that some of the assumption that those good results will in fact happen is already baked into the Dow's current level, and so future returns might not be as strong even if earnings do pick up in future.
