Greater Profit Warnings Weigh on Stocks

Every quarter, companies that expect their profit to fall short of forecasts tend to break the bad news to investors even before the quarter ends.

So why does Wall Street seem to be taking it so hard this time around?

The stock market’s slump over the last two weeks, while most likely driven in part by higher energy prices, also can be attributed to a rash of corporate warnings about weaker-than-expected third-quarter earnings, analysts say.

For the week, the Nasdaq composite index sank 3.6%, the Standard & Poor’s 500 lost 1.9% and the Dow industrial average gave up 2.6%, ending Friday at 10,927.00, its lowest since Aug. 10.

Companies warning about near-term profits have included McDonald’s, DuPont, Crane, Watson Pharmaceuticals and electronics manufacturer SCI Systems.

The profit-shortfall reasons cited have included higher raw materials costs (mostly energy), weaker demand and the slumping euro currency.

One simple reason the stock market may be spooked is that there have been more announcements than usual so far.

There have been 110 warnings of lower-than-expected earnings thus far in the quarter, according to First Call. That’s up from 69 at the same time last quarter.

Analysts appear to be trimming earnings estimates for a broad range of companies.

Two months ago, analysts expected companies in the Standard & Poor’s 500 to report overall earnings growth of 19.2% in the third quarter compared with a year earlier, according to First Call/Thomson Financial.

Now, with the end of the quarter two weeks away, that overall forecast has fallen to 17.2%.

The outlook for quarterly earnings growth at consumer products firms has fallen to 6% from 15% since April. Predictions of profit growth for transport companies have dropped to 25% from 36%.

Part of the problem is that Wall Street has been spoiled by the rapid profit growth at many U.S. companies in 1999 and in the first half of this year, amid a booming economy. Earnings growth for the companies in the S&P; 500 was 23.6% in the first quarter, the highest in more than six years.

“Earnings are still terrific, but they ain’t what they were,” said Vincent Farrell, who helps manage $4.5 billion at Spears, Benzak, Salomon & Farrell Inc. The slowdown “is going to get reflected in the prices people are willing to pay for stocks.”

The U.S. economy perked along at an 8.3% annual rate in the fourth quarter of 1999. The growth rate slowed to a still-robust 5.3% rate in the second quarter. Many economists now expect growth to slow further to a 3%-to-4% rate the second half of this year.

If growth is slowing, that must mean sales at many companies also are slowing.

And that means warnings from companies such as SCI Systems could become more common. The firm, which builds personal computers for other firms, said Wednesday that fiscal first-quarter profit wouldn’t meet forecasts in part because PC sales fell.

Tech companies, whose price-earnings ratios are generally higher than non-computer-related firms, will be hurt the most if earnings disappoint, analysts warn.

“Things are going to be yucky and in tech it’s going to be a real debacle,” argues William Fleckenstein of Fleckenstein Capital in Seattle.

Other analysts, however, say it’s too early to be overly bearish about earnings, with many companies continuing to boost their results via productivity gains, even if sales slow.