Rally Fundamentals Are There—Just One Important Thing’s Missing
Everything in business is based on confidence—without it, the whole system comes apart. If it’s one thing I’m confident about these days it’s corporate earnings. The stock market will convulse if it wants to, but what’s most important in my mind is what corporations are saying about their businesses.
In another good sign for this earnings season, the largest drugstore chain in the United States, Walgreen Co. (NYSE/WAG), reported excellent earnings that beat consensus, but also showed a solid improvement in revenues. This is a positive sign for the retail economy.
According to the company, its earnings were 792 million dollars, or $0.87 per share, in its latest quarter ended August 31, 2011. This compares to earnings of 470 million dollars, or $0.49 per share. Excluding a one-time gain, Walgreen’s adjusted earnings were $0.57 per share, topping Wall Street expectations of $0.55 per share. The company’s revenues grew just over six percent during the quarter to 17.96 billion dollars. Revenues from stores open at least a year grew 4.4%.
Another very positive earnings report came from office furniture maker Herman Miller, Inc. (NASDAQ/MLHR), which reported very good financial results that also beat the Street. The company announced fiscal first-quarter revenues, ended September 3, 2011, of 458.1 million dollars, representing a solid increase of 20% over the same quarter last year. Company management cited that its gross margin improved 120 basis points, as the business was able to increase its prices without affecting demand. This went straight to the bottom line, as earnings grew to 24.6 million dollars, or $0.42 per diluted share, compared to earnings of 16.1 million dollars, or $0.22 per share, for an impressive gain of 91% on a per-share basis.
Of course, not all industries are doing well and it’s pretty obvious that the slow economy is hitting small businesses the most. But the general trend in corporate earnings is still very positive and, from my perspective, it makes the current stock market somewhat undervalued.
The S&P 500 Index has been experiencing a correction since July of this year. The Index dropped from approximately 1,350 to its current level around 1,200. That’s a meaningful correction and fits into the medium-term trend from the market low in March of 2009.
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If the Europe sovereign debt crisis can be abated, then I think the probability of stocks experiencing a solid rally will increase significantly. All this market needs is confidence—confidence that the euro currency won’t come apart and that the U.S. economy is stabilized and poised for improvement.
With corporate earnings expected to be strong once again, stocks should jump smartly on any good news on the economic front, however small. The caveat is Europe. If confidence in European sovereign debt can be improved, stocks could move much higher over the near term. If confidence deteriorates, all the good earnings results won’t mean a thing.