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Third-Quarter Results May Jolt Investors : Markets: The amazing thing is that lower earnings are taking some by surprise.

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TIMES STAFF WRITER

It’s show time for third-quarter corporate profits. Based on a few peeks under the curtain last week, this production could be a bomb.

Many big investors seem woefully unprepared for bad earnings news, even though a host of major companies have clearly stated that business stumbled in the third quarter as the economy soured:

* Last Thursday, machinery maker Ingersoll-Rand announced that a sudden decline in business meant third-quarter results would be below the 90 cents to $1 a share that Wall Street had expected. The news sent its stock down $5.875 to $33.25, a drop of 15%.

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* Likewise, conglomerate Tenneco saw its shares plunge $4.75 to $45.25 on Thursday after a Prudential-Bache Securities analyst cut earnings estimates, citing slower sales at Tenneco’s farm and construction equipment unit.

* Insurance giant Travelers Corp. on Friday slashed its dividend 33%, blaming growing real estate investment losses. The stock plummeted $4.375 to $16.375, dragging other insurance stocks down with it.

What’s amazing about these stock losses is that investors still could be surprised by what everyone already knows is a bad situation: a weak economy that’s getting weaker. Especially in the case of companies in basic industry--such as metals, machinery and chemicals--earnings expectations have already been cut sharply. But evidently not sharply enough.

Indeed, money managers may be relying too closely on analysts’ methodical number crunching instead of viewing stocks from gut-level economic expectations, some experts say.

Melissa Brown, who tracks earnings trends for Pru-Bache, notes that analysts’ figures suggest that third-quarter earnings on average will be up 8% from a year ago. “This expected growth still seems high to me,” Brown warned clients in a recent report. “I suspect that much higher oil prices have not yet made their way into analysts’ estimates in some industries.”

Given Wall Street’s still-optimistic profit growth expectations for key industries--including diversified manufacturing, semiconductors, S&Ls; and business services--there is huge potential for major disappointments in the weeks ahead as third-quarter figures are reported, some warn.

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“In the current environment, these are make-or-break numbers,” says D. Jonathan Merriman at Curhan, Merriman Capital Management in Los Angeles. Even though many companies will have easy comparisons with a lousy quarter in 1989, “you’re still going to have problems” because of the slumping economy, Merriman fears.

What is perhaps most worrisome is that many technology companies, in particular, never know how good a quarter they’ll have until the very end, because many order decisions are made in the final two weeks of each quarter. Last Thursday, Digital Communications Associates, which designs computer networking systems, said it earned just 18 cents a share in the third quarter, down 63% from a year ago.

“There was no warning,” said Ben Zacks of earnings-tracker Zacks Investment Research in Chicago. Of eight Wall Street estimates that Zacks had for Digital, “the lowest was 45 cents a share,” he said. Not surprisingly, investors crushed the stock down $4.375 to $10.625.

Obviously, no matter how much big investors try to persuade themselves that they’re prepared for bad news in this economy, the selloff of Digital, Ingersoll-Rand, Travelers and other stocks show that isn’t true. Disappointing earnings come over the ticker tape, and many money managers hit the eject button.

Jeffrey Cohen, portfolio manager at NWQ Investment Management in Los Angeles, says his $2.5-billion firm didn’t sell its roughly 400,000 Ingersoll-Rand shares last week, despite the earnings bomb. “We’re long-term investors with a three- to five-year time horizon,” he says. “From a value perspective, a lot of these stocks now are too cheap to sell,” he adds. NWQ believes that a global capital spending boom in the mid-90s will benefit Ingersoll-Rand in a big way.

But in the meantime, Cohen admits, “if you own any industrial stock that hasn’t yet been hit, you’ll want to give it a hard look, because it’s probably next in line.”

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The worst surprise of the next few weeks may be that that line is much longer than most investors thought--and that it contains a lot more than industrial stocks.

WAITING FOR THIRD-QUARTER PROFITS

Based on analysts’ consensus estimates, here’s how third-quarter corporate earnings are expected to come in for key industry groups. The numbers are averages for companies in each group:

HIGH EXPECTATIONS Group: Est. change vs. year ago Divers. manufacturing: +52.3% Semiconductors: +41.3% Engin./construction: +36.6% S&Ls;/mtg. finance: +31.2% Hospital management: +30.3% Pollution control: +27.4% Business services: +27.0% Tobacco: +24.0% Drugs: +22.3% Apparel retailers: +19.0% LOW EXPECTATIONS Group: Est. change vs. year ago Autos: -47.1% Steel: -33.9% Aluminum: -32.1% Homebuilders: -29.8% Chemicals: -28.7% Machine tools: -26.0% Hotel/motel: -20.9% Brokerages: -20.0% Money center banks: -14.9% Newspapers: -12.9% Source: Prudential-Bache Securities, using Lynch, Jones & Ryan data

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