Which Group of Analysts Will Be Right About Earnings?

By Chad Brand of Peridot CapitalistGlancing over earnings estimates for the duration of this year and 2007, I noticed a very interesting dichotomy. Bottom-up analysts are still quite bullish on corporate profits, forecasting year-over-year growth in each of the four calendar quarters during 2007. Top-down analysts, conversely, are predicting annual declines in earnings beginning in Q3.Which group will be correct? It’s simply too early to know. I would tend to side more with bottom-up analysts in general, merely because they are basing their forecasts on what actual company management teams are saying, as opposed to merely taking a broad macroeconomic view of the world.That said, I am worried that earnings growth will be difficult to maintain. Over the last couple of years a majority of the gain in S&P 500 earnings have come from the energy and materials sectors. As we head into next year, contributions from these groups could be minimal, if not negative. Commodity prices seemed to have peaked for the short term, and although I do think we are in the middle of a secular bull market in the group, there is no reason to think we could not see a breather in the run during 2007.If energy and other commodity stocks find it difficult to grow earnings, other groups would have to see accelerating profit growth to make up the difference and continue to boom in corporate earnings. I can’t really see what areas would be up to the task.What is the implication for stock prices going forward? Depending on what earnings number one uses for the S&P 500, we are currently trading between 15 times (operating) and 16.5 times (GAAP) 2007 earnings estimates. Market bulls suggest that P/E multiples should expand given the outlook for economic and earnings growth. However, if corporate profits begin to see year-over-year declines in the back half of 2007, such multiple expansion is unlikely.With multiples staying flat or declining, and profits peaking, it would be hard to make the case that stock prices have a lot of room to run next year. Perhaps that is why the S&P 500 seems to be having trouble breaking past recent highs in the 1,390 area. As it stands right now, I don’t see the S&P breaking meaningfully above 1,400 in the short term until we have increaased confidence that a more bullish scenario could play out.

Sponsored: Attention Savvy Investors: Speak to 3 Financial Experts – FREE

Ever wanted an extra set of eyes on an investment you’re considering? Now you can speak with up to 3 financial experts in your area for FREE. By simply clicking here you can begin to match with financial professionals who can help guide you through the financial decisions you’re making. And the best part? The first conversation with them is free.

Click here to match with up to 3 financial pros who would be excited to help you make financial decisions.

Thank you for reading! Have some feedback for us?
Contact the 24/7 Wall St. editorial team.