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What Do 2013 Earnings Estimates and Icarus Have in Common?


Since October, estimates are being ratcheted down as margins show a change in trend, falling for the first time since 2009. Still, full year 2013 earnings remain too elevated.

In Greek mythology, Icarus failed in his attempt to escape the island of Crete because he succumbed to hubris and didn't heed his father's advice.
Icarus' father repeatedly warned that the wings he had built were made of only wax and feathers and would melt if Icarus attempted to fly too close to the sun with them.

The story ends with Icarus falling to his death. Icarus got caught up in the euphoria of flying and made the mistake of becoming overly ambitious in his escape.

Perhaps we too should take a step back from our giddiness when it comes to 2013 earnings that may also still be flying too high.

Bottoms Up Earnings

Earnings season for 4Q 2012 is in full swing with 78% of constituents reporting and a few of the larger retail ones still remaining.
On 2/27 Target (NYSE:TGT) reports and on 2/21 is Hewlett-Packard (NYSE:HPQ) and Wal-Mart (NYSE:WMT). March wraps up with some more large retailers like Costco (NYSE:COST) and Staples (NASDAQGS:SPLS).

The Top Down Earnings

2012's S&P 500 (NYSEARCA:SPY) reported earnings are expected to reach a new all time high at $88/share. For comparison, 2011's reported earnings were $87/share and 2Q 2007 trailing (the previous stock market peak) was $85/share.

By the end of 2013, analysts are expecting earnings to grow 15% to another all time high of a reported $101/share. Below are the latest S&P earnings for the past year and next year's reported estimates in columns 1 and 2, annual growth rates in column 3, and a comparison of today's estimates with the ones that were estimated back in October in columns 4-6 (when I wrote another article on the lofty earnings found here). Since then earnings estimates have come down, but is it enough?

It seems analysts and companies are all expecting continued earnings growth into next year as the above S&P data supports. But very few seem to be concerned that earnings growth continues to be ratcheted down and pushed out as the latest headline from Forbes identifies, but doesn't comment on, "S&P 500 Revenue and EPS Estimates Ratchet Down After January Results."

After the dust has settled, full year 2012 earnings barely grew at all (estimated now to be only 1.2% over 2011), but 2013 full year earnings are still expected to grow even more than 2011's impressive 12.4%. Even more, margins are now starting to fall for the first time since 2009 (more on that below).

All four of the latest earnings quarters have been clawed back, some significantly, yet 4Q 2013 remains unscathed and elevated as companies are unwilling (so far) to come off of full year guidance, adding up to a 15% year over year growth.

On Oct.9, 2012 with the S&P at 1450 we first identified earnings estimates as being too lofty.

Those estimates indeed have fallen and we were able to take advantage of the market's technical decline into November in our Technical Forecast published Oct.10, "If price continues to fall from its high today below both the medium term uptrend channel that connects July, Sept, and now Oct lows as well as 1450, then shorts can be opened up with the assumption that 1430 will be visited again." 1430 was indeed visited again, as was 1374, where we took short profits.

What's That You Say About Margins?

Like Icarus, analysts it seems are assuming earnings can go up forever into perpetuity. But in reality, S&P earnings are cyclical and are now starting to slow. They rise and fall over time based on normal macro cycles.

There is easy justification for this cyclicality. When earnings rise, so do margins. When margins rise, competition steps in as barriers to entry are able to be overcome. Competition then puts pressure on pricing. This lowers margins and eventually earnings. If there is any doubt to this economic fact, just research the Android (NASDAQ:GOOG) versus Apple (NASDAQ:AAPL) situation unfolding.
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