Quarterly Earnings Looking Good... Time to Buy?

We are in the midst of one of the best quarterly earnings seasons on record.

More than four out of five companies are topping consensus estimates on profits. The S&P 500, that big index of America’s largest companies, is set to break a run of nine consecutive quarterly declines in profits.

This doesn’t mean stocks are a buy. The big rally stocks enjoyed in 2009 baked in much of that recovery. However, unlike prior quarters, it’s not just cost cutting that’s driving those profits. Sales are starting to tick up again. Nearly two out of three companies are beating sales forecasts.

What happened? The good recession happened (at least where government bailout money did not get there first). The bitter winter of recession thinned the herd. It’s an ongoing process. For instance, a recent Wall Street Journal headline reads ‘Radical Shifts Take Hold in U.S. Manufacturing.’ It pointed out that Dow Chemical would shed $2 billion worth of basic chemical factories to shift into more profitable specialty chemicals. Whirlpool is cutting 1/10th of its capacity. Yet Intel is investing billions in its US plants to meet new demand.

In a big-picture sense, what we are seeing is a squeezing of the economic sponge. The market process forces people to liquidate the bad businesses and purge mistakes. The excess capital is then free to go elsewhere and find better returns. And the capital that remains in a business earns a better return for its owners. Or put another way, capital flows out of the Whirlpools and toward the Intels. Thus, we plant the seeds of recovery.