US profits forecasts are 'wildly optimistic'

published 6 August 2010

Once again, analysts' earnings growth estimates for the firms in the S&P 500 index look "wildly optimistic", says Spencer Jakob in the FT. There is ample scope for disappointment. Analysts expect profits to grow by 33% this year and another 16% in 2011. That would imply a new annual record of $96 a share. This includes the assumption that margins will reach 9.1% next year, a level seen at the peak of the boom years.

And that figure was boosted by a financial sector reporting "artificially high profits during the housing boom". The average over the last 13 years has been 6.8% and "there are few economic series that revert to the mean as reliably as corporate margins". Forecast revenue growth of 6.3% next year also looks a stretch.

Wildly bullish earnings expectations tend to be bad news for US equities as reality falls short of forecasts. Stockmarket historians at Ned Davis Research calculate that annualised returns fall to 12% when earnings expectations exceed 15%. Low expectations presage a strong market performance. When earnings forecasts fall under 5%, annualised returns average 18%. This bout of optimism could be "setting stocks up for a fall".