Earnings Expected to Fall

On top of their many other worries, stock investors in the next few weeks are likely to be officially confronted with this gloomy fact: Corporate earnings are falling for the first time in seven years.

For the just-completed third quarter, operating earnings for the companies in the blue-chip Standard & Poor’s 500-stock index are predicted to fall 2.6% from a year ago, according to analyst estimates compiled by First Call Corp.

That would mark the first time aggregate earnings have dipped since the third quarter of 1991, when the U.S. economy was emerging from recession.

The overall S&P; 500 earnings number still may turn out to be flat or even slightly positive for the quarter. Analysts are notorious for low-balling numbers so that companies can top their predictions.

But with a shaky world economy hurting many U.S. companies’ results--including such large and normally reliable firms as Gillette and Coca-Cola, which have already warned about weaker-than-expected earnings--the near-term profit picture appears bleak, analysts say.

When the third quarter began, analysts thought S&P; 500 profits would expand at a decent 10% clip this quarter, even though the growth rate had fallen to 3.8% in the first quarter and 3.5% in the second.

“The bottom line is analysts had been very optimistic on earnings growth [because of] healthy gains in the worldwide [economic] growth scenario,” said Scott Bleier, chief investment strategist at Prime Charter Ltd., a New York investment bank. “Now, that growth scenario no longer exists.”

However, the news is not entirely bad. The number of so-called negative pre-announcements for this quarter, in which companies warn about poor earnings to come, is slightly lower than at the same point last quarter.

So far, there are 290 negative pre-announcements, which account for 60% of all the third-quarter pre-announcements.

Just after the second quarter ended, 304 companies, or 68% of the pre-announcement total, had given negative warnings.

Bulls point out that while a number of major companies have issued warnings, other blue-chip leaders such as Microsoft and General Electric seem on track for healthy earnings gains. Intel, the computer chip giant, is expected to beat published forecasts.

Yet only a handful of industry groups are projected to notch strong third-quarter earnings.

Profits for drug companies are expected to rise 18%, according to First Call. That includes a 15% rise for Merck, 22% for Pfizer and 42% for Warner-Lambert.

But technology earnings, while expected to improve over a dismal showing in the first half of the year, are still lackluster. After sliding 9% in the first quarter and 8% in the second quarter, technology profits overall are expected to improve only 4%.

Profits of financial companies, whose stocks have been clobbered recently amid fear over rising investment and loan losses, are expected to drop 4%, compared with a 14% rise in the second quarter.

Among the biggest losers, energy company earnings are forecast to slump 36%. The scenario is much the same for other commodity-based industries, such as paper products and precious metals, where earnings are expected to drop 20%. Commodity prices have fallen sharply because of deflationary forces arising in part from the Asian financial crisis.

Even in some industries with strong growth estimates, the numbers may be misleading. Profits at apparel makers, for example, are expected to grow 35% this quarter. Restaurants and major retailers such as department stores are on target to increase profit by 14% each.

Those companies have been helped by buoyant U.S. consumer spending. But if the stock market is any gauge, those groups are enjoying their last hurrah. S&P;’s retail-store stock index has skidded more than 14% in the last week and a half on the belief that the economy will slow significantly.

Rather than focus on operating earnings, which exclude one-time gains and losses (such as from restructurings), Richard Bernstein, chief quantitative analyst at Merrill Lynch & Co., focuses on final net income. And by that measure, earnings fell in each of the first two quarters of this year. A “profits recession” is already in progress, he said.

What’s more, Bernstein’s gauges of future earnings are negative.

“Every single one of our indicators is pointing straight down,” Bernstein said. “The profits recession is deeper than most people think and will last longer than most people think.”

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The Thinning Bottom Line

Earning growth for the blue-chip Standard & Poor’s 500 companies has shrunk dramatically in recent quarters, and analysts now expect third-quarter profits to decline--the first year-over-year drop since 1991. Quarterly operating earnings growth since 1995 of the S&P; 500-stock index, and analysts’ third-quarter estimate, as compiles by First Call:

1998, Third-quarter estimate: -2.6%

* Source: First CAll