Take Out Stock Buybacks and Corporate Earnings Growth Negative?

stock buybackThe results are in…

Thus far, 460 companies on the S&P 500 have reported their corporate earnings for the third quarter of 2013. The average increase in earnings per share for these companies in the third quarter compared to the same quarter of last year was 3.5%. (Source: FactSet, November 8, 2013.)

My bet is that if you take out the record number of stock buyback programs the S&P 500 companies have announced this year, earnings for the third quarter of 2013 were flat. (I have my research staff working on these numbers, and I will be able to quantify this for my readers in the next few days.)

Yes, per-share earnings of the S&P 500 (before stock buybacks) are flat year-over-year, but the S&P 500 is up 30% over the same period. How can that make sense?

Well, S&P 500 corporate earnings are not even the most disturbing part…

Only a little more than half of the S&P 500 companies (52% to be exact) were able to beat their revenues estimates—a trend that has become common over the past few quarters, where per-share earnings rise but revenues remain flat.

A few of the biggest names on key stock indices have actually reported a decline in revenue. For the three months ended on September 30, News Corporation (NASDAQ/NWSA) reported a three-percent decline in its revenue from the same period a year ago, with revenues falling to $2.07 billion compared to $2.13 billion in the same quarter in 2012. (Source: News Corporation, November 11, 2013.)

And, of course, we have companies continuing to buy back their stock to boost per-share earnings. Take Xerox Corporation (NYSE/XRX), for example. This S&P 500 company just announced it was adding another billion dollars to its share buyback program as it reported corporate earnings in the fourth quarter will now be in the $0.24-$0.26 per-share range, compared to its previous estimate of $0.28-$0.30 per share. (Source: Reuters, November 13, 2013.)

To make matters worse, 73 of the S&P 500 companies have issued negative earnings guidance for the fourth quarter, while only 12 have issued a positive outlook.

The bottom line is S&P 500 companies in key stock indices are missing on their revenues, while their per-share earnings are propped up by stock buybacks. I remain skeptical of the performance of key stock indices like the S&P 500, as their weak per-share earnings growth is being achieved via artificial measures. The fundamentals of good, honest, old-fashioned revenue and earnings growth are clearly missing.

With that said, irrationality prevails in the stock market these days and those who have a similar opinion to mine are rare. My fundamental data backing me up are saying this stock market has gotten way ahead of itself…the risks are piling up each passing day.

Michael’s Personal Notes:

The direction of prices in the housing market has historically been dependent on the direction of mortgage interest rates. If mortgage rates start to increase, it makes homes less affordable for those who want to buy. The math is simple: the higher the mortgage interest rate, the higher the mortgage payment is going to be for the home owner and the more difficult it becomes to keep up with payments—something we learned in the housing market crash of 2007.

Mortgage interest rates are rising, and I believe the U.S. housing market will suffer as a result. Of course, interest rates are nowhere close to what they were in the 1980s, but they are up significantly this year from their lows. The 30-year fixed mortgage rate tracked by Freddie Mac stood at 4.19% this past October. In the same period a year ago, the rate was sitting at 3.38%. (Source: Freddie Mac web site, last accessed November 12, 2013.)

The effects of demand for housing given higher interest rates can be seen in the chart below. The number of new homes sold in the U.S. housing market has been declining since the beginning of the year.

 Houses Sold- New One Family Chart

Chart courtesy of www.StockCharts.com

In early 2013, the annual rate of new homes sold in the U.S. housing market was close to 460,000 units. This number came in at just 421,000 units in August, down eight percent.

The weakness in the housing market can be seen in the statistics being released by new home builders. For example, D.R. Horton, Inc. (NYSE/DHI), a large U.S. homebuilder, said that in the fourth quarter of its fiscal year 2013 (which ended on September 30) the cancellation rate (that’s the rate of home buyers canceling their purchase contracts) stood at 31%. (Source: D.R. Horton, Inc., November 12, 2013.) Last fiscal quarter, the company’s cancellation rate stood at 24%, and in the second fiscal quarter, it was 19%! The number of people walking away from deals at DR Horton is skyrocketing, and if we checked the rates of other homebuilders, I’m sure we’d see the same trend.

Despite the occasional bounce here and there that comes from this overheated stock market, homebuilder stocks have been declining in price since May of this year. They are telling us something is up with the U.S. housing market, and it’s not good.

What He Said:

“We will wish Greenspan never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi in Profit Confidential, April 27, 2004. Michael first started warning about the negative repercussions of Greenspan’s low interest rate policy when the Fed first dropped interest rates to one percent in 2004.