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If you tally up company-by-company consensus forecasts for
he Standard & Poors 500 index, it would suggest
earnings-per-share growth for the index in aggregate in the low
teens for this year and next. But Investors arent buying
it. In their view, the sputtering economy makes recent
near-record U.S. profitability unsustainable. In fact, stocks
have been priced at levels that would suggest a 15 percent drop
in S&P 500 EPS next year an event typically confined
to recessionary periods. Our research indicates that EPS will
prove more resilient than many investors believe.
A sensitivity analysis conducted by my colleague Brian Lomax
found current consensus estimates reasonable, even assuming
abnormally weak GDP growth. Factoring in stagnant GDP and a
decline in net margins to 2010 levels, his model indicated that
the S&P 500s EPS would decrease only about 3 percent,
to $96, from the consensus forecast of $99 for 2011.
Thats far less dire than market valuations suggest.
There are three important factors at work here: First,
S&P 500 sales should grow faster than the economy, as they
have historically. Second, U.S. companies still have tremendous
operating leverage at their command. For nonfinancial companies
in the S&P 500, the incremental margin the potential
profit produced for every extra dollar of sales is
currently 12 percent, double the 6 percent historical average.
Net margins should continue to be buoyed by higher foreign
profits and pricing power (as indicated by the pickup in
year-over-year producer prices since 2010) and subdued labor
The third factor, which gets little attention from
investors, is the enormous untapped financial firepower in
cash-rich, low-debt U.S. balance sheets. With companies under
intense pressure to put their low-returning cash hoards to
more-profitable use, we expect spending on initiatives that
could boost EPS, such as acquisitions and share
Indeed, M&A activity and buybacks continued in the face
of the markets extreme volatility in recent weeks.
Apparently, corporate managers arent as shaken by world
events as equity investors are. By our analysis, the average
EPS of the S&P 500 would increase by $5 if companies simply
pared cash balances to a more reasonable 5 percent of assets
from their record level of 8 percent today and use the cash to
buy back stock.