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2006-08-21 :: Earnings Growth in the Second Quarter

The chart below from Dirk Van Dijk shows earnings growth for the various industrial sectors.  Not surprising, Energy is at the top, with 65.62% earnings growth during the second quarter.  Others of my favorite sectors are also near the top, Industrials and Materials.

At the bottom, you’ll see Consumer Staples, the industry group that has been acquiring the most interest recently as the talking heads have been telling everyone to move into defensive stocks.

When you invest in a company, you are really purchasing a stream of future earnings.  A stream that is growing 65% is inherently more valuable (particularly when you pay 7, 8, or 9 times those earnings as measured by the P/E ratio) than a stream growing by 5% (and you are forced to pay 22 times those earnings as measured by the P/E ratio). 

The traditional rule is that during an economic slowdown, you move into defensive stocks.   I read those books, too, in my Masters classes, but come on…how about some independent thought and reasoning.  We are now living in a world economy, not in a compartmentalized US economy.  At the margin, world-wide liquidity is tightening, but not enough to throw us into a worldwide recession.  As proof of that, one of the most sensitive economic indicators, the Baltic Dry Index of shipping rates on the world’s busiest shipping routes, is booming; its up 60% over the last three months.  Oh, those three months also correspond to the period when the defensive stocks have been outperforming those stocks tied to economic activity.

The current lull in the economically sensitive stocks is only natural after a few years of outperformance.  But the earnings growth numbers will prove to be the deciding factor and all of the people that moved into defensive stocks will miss the turn in the market. 

Based upon recent reports they’ve published, Citigroup and Goldman Sachs are both clearly in the corner that says that the economically sensitive stocks are due to turn around soon.  Most of the rest of Wall Street is pushing for the defensive stocks.   When in doubt, follow the earnings; they generally lead to profits, particularly for investors.

More later!

Mark

Sector Q2 Median
Growth Rep.
Q3 Median
Growth Exp.
2006 Median
Growth (Exp)
Q2 Median
Surprise
% Reported Pos
Surprise
Neg
Surprise
Match
Energy 65.62% 25.00% 29.39% 4.82% 96.67% 21 8 0
Industrials 18.64% 17.48% 16.67% 3.22% 94.34% 38 7 5
Telecom 16.88% 19.26% 2.42% 6.90% 100.00% 8 1 0
Materials 14.82% 21.43% 23.93% 3.62% 100.00% 24 5 1
Utilities 13.33% 7.76% 3.25% 7.59% 100.00% 20 8 3
Cons. Disc. 11.11% 8.33% 10.93% 4.65% 91.86% 60 10 9
Health Care 10.61% 8.47% 10.64% 4.17% 94.64% 42 7 4
Financials 9.91% 8.51% 10.53% 3.13% 97.70% 61 17 7
Tech 8.58% 7.57% 10.18% 3.85% 81.01% 39 16 9
Cons. Staples 5.00% 3.39% 6.70% 3.39% 89.74% 26 6 3
S&P 500 13.21% 9.38% 11.48% 3.90% 93.00% 339 85 41