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Corporate results’ disconnect with share prices

The profits picture painted so far by US companies has given little indication of a pick-up in earnings growth, supporting the argument that the stock market had come too far, too fast. Of particular concern is the still-sluggish growth in sales.

Revenue growth is projected at just 0.6 per cent for the fourth quarter, although the overall number of companies exceeding sales forecasts is better than the third quarter and the long-term average.

Still, more beats on revenue have not been enough to boost a stock market that was viewed as in danger of a correction heading into 2014. Rising concerns about global growth and less Federal Reserve Bank support have encouraged heavy selling.

With results in from roughly a quarter of the Standard & Poor’s 500 companies, 70 per cent are beating analysts’ revenue estimates, above the long-term average of 61 per cent for a full reporting period, according to Thomson Reuters data.

Some of the sales misses have come from such high-profile names as IBM, while companies still are resorting to cost-cutting to boost the bottom-line, underscoring a weakness in sales that has long darkened the profit picture.

After last year’s nearly 30 per cent gain in the stock market, results have done little to support prices, which by valuation metrics such as price-to-earnings ratios are currently seen as a bit on the expensive side.

“This is a transition period as the Fed throttles back,” Quincy Krosby, market strategist for Prudential Financial, said.

Early results are showing more of the same that investors are used to with earnings, including cost-cutting. “You’ve heard that from a number of companies in different sectors,” she added.

Texas Instruments Inc., for instance, posted sales that beat analysts’ expectations, but the US chip maker also said it would cut about 3 per cent of its global workforce.

Sales at IBM fell 6 per cent in emerging markets, including a 23 per cent tumble in China, and the company only managed to beat earnings estimates thanks to a reduced share count and lower tax rate.

“There’s revenue growth. It’s just not as robust as we would like,” Nick Raich, chief executive of The Earnings Scout, said.

There have been exceptions. Netflix Inc., the S&P’s best performer in 2013, beat estimates for subscriber growth, resulting in a big jump in its shares.

Coming into the year, strategists looked to a more robust US economy to boost profits and corporate spending. Analysts at Goldman Sachs note that, typically, market rallies allow for price-earnings multiples to rise until the S&P’s forward P/E reaches about 15.

Stocks can keep rising thereafter, but sales growth has to come into play, they added. So far, sales growth has been disappointing, and the current forward P/E of about 15.3 is seen as getting expensive.

“The market’s going to demand top-line [growth] at some point. I would have thought that that time would have already come, and it hasn’t,” Uri Landesman, president at Platinum Partners, said.

Some sectors have been better than others. The early run of reports from banks were generally positive, with analysts at Bank of America-Merrill Lynch noting lower expenses and credit costs, offsetting weak trends in lending and fixed income trading.

Goldman expects capital expenditures to rise 9 per cent in 2014, compared with a meagre 2 per cent rise in 2013, based on increased capacity utilisation, low funding costs and rising consumer confidence.

While some companies have announced plans for more spending, it is not enough to suggest the tide is turning on the spending. Investors have been trying to gauge how quickly the Fed will wind down its bond-buying stimulus that has helped keep a lid on interest rates and made borrowing favourable.

“It’s not like there’s no spending,” Raich said. “The key question is if rates go up, will there be further retrenchment from the CEOs. It’s all about that confidence from them.” Corporate balance-sheets currently hold about $1.3 trillion in cash, excluding financial companies, according to Goldman Sachs.

Overall, 64 per cent of companies have beaten profit expectations, close to the 63 per cent long-term average for a full reporting period.

But estimates for 2014 still appear too optimistic — full-year earnings growth currently is forecast at 10.4 per cent, a figure likely to come down. “If estimates for 2014 as a whole don’t start to come down, we don’t think they can necessarily be beaten,” said Michael Mullaney, chief investment officer at Fiduciary Trust Co.