28 Clues That Earnings Are Getting Stronger

Earnings season is nearing its end, so I thought I'd take a snapshot look at how reporting companies fared. According to Bespoke Investment Group, 74% of companies reporting earnings between October 26 and October 30 beat estimates. Unfortunately, this was much lower than earlier in the month when the "beat rate" was much higher. It concluded that the beat rate got progressively lower throughout the month, and that this explained the sluggishness in the markets in October. Maybe, but I see the results in an entirely different way. In fact, I have 28 clues to suggest that earnings are actually getting stronger.

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October 29: 28 Companies Beat Estimates By 100%

Small Caps Rule The Roost
Not surprisingly, of the 28 stocks that beat estimates by 100% or more on October 29, three quarters of them were small caps. With fewer analysts covering these companies, the average estimate has a greater chance of being wrong. That's expected. However, what's interesting to me is the size of the earnings surprises from the larger stocks. The six mid caps that beat estimates by more than 100% and reported October 29 had an average earnings surprise of 619%. That's almost three times the average small cap upside surprise. Some might disagree with my opinion, but to me this fact suggests business conditions are improving. The fact that the markets aren't necessarily building this into current prices is part of its charm. The job of investors is to find those stocks with the biggest discrepancies in valuation and buy them.  

Not Falling Off a Cliff
The largest of the 28 positive surprises is Cliffs Natural Resources (NYSE:CLF), a Cleveland-based iron ore and coal producer with mines in four states as well as Canada and Australia. It beat estimates by 1600%, or 45 cents, a far cry from analyst expectations of a three-cent loss. Not only did it produce surprise earnings, but it beat revenues as well, delivering $666.4 million in sales versus analyst estimates of $634.6 million. The improvement in its business stems from increasing demand from its North American customers for iron ore and metallurgical coal. If that's not a sign the economy is slowly mending, I don't know what is.  

Mid Cap Financials Did Well
Two financial services companies reported much higher earnings than expected October 29. One is a stellar business built in the Berkshire Hathaway (NYSE:BRK.A) model, the other is recovering from a near-death experience. Fairfax Financial Holdings (NYSE:FFH) reported earnings per share of $30.88, 211.6% better than analyst estimates of $9.91. Why such a large beat? Prem Watsa, CEO and founder of the Canadian holding company, had this to say about its third quarter: "We ended the quarter with common shareholders' equity of $7.5 billion and a book value per basic share of $371.85; including the $8 per share dividend paid in the first quarter, book value per share was up 36.1% in the first nine months of the year. Our company has never been stronger." Now contrast this to Genworth Financial (NYSE:GNW), the one-time General Electric (NYSE:GE) subsidiary that was spun-off in 2004. Hurt by the housing market collapse, its stock dropped as low as 84 cents in March, only to rebound nicely, up 270% year-to-date with all of it coming in the last six months. And no wonder. In its latest Q3 report, it beat estimates by 1000%, or 18 cents, versus analyst expectations of a two-cent loss. This dog does hunt. 

Bottom Line
When you're trying to dig yourself out of a financial mess, you need to take baby steps to extricate yourself from the situation. Eventually, you get stronger until the mess is gone. That's exactly what's happening with our economy. Businesses are reporting earnings that are surprising on the top line, not just on the expense-cutting bottom line. It's a sure sign things are getting better - even if it's not at the speed we'd like. (To learn more, see Surprising Earnings Results.) 

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