Earnings Growth at Blue-Chip Firms May Ease for Part of ’06

U.S. blue-chip companies extended their streak of double-digit earnings growth through the fourth quarter. But that may be as good as it gets for a while.

Average profit growth of firms in the Standard & Poor’s 500 index is expected to decelerate this quarter to the slowest pace in nearly three years, based on Wall Street analyst estimates compiled by data tracker Thomson Financial.

So far, the stock market seems to be accepting the idea of a profit lull without much fuss -- perhaps because analysts are optimistic about a strong rebound in the second half of the year.

With more than 90% of S&P; 500 companies having reported their fourth-quarter results, the year-over-year increase in earnings for the index overall is estimated at 14.1%, according to Thomson.

That figure is for operating earnings, which are results before one-time gains or losses.

If that 14.1% growth estimate holds up once all profit reports are in, it would mark the tenth consecutive quarter of double-digit growth for the S&P; 500, by Thomson’s reckoning.

Other analysts say the streak is even longer than that. Standard & Poor’s, which calculates operating earnings differently than Thomson, estimates that blue-chip companies’ profits have risen at a double-digit pace for 15 straight quarters, a record.

The earnings boom has been a byproduct of the global economy’s expansion since 2002, which itself has been powered in large part by U.S. consumers’ robust spending. Sharp gains in worker productivity also have boosted companies’ results.

But in the first half of this year, the rate of earnings growth is expected to be pulled down by weakness in some consumer-dependent industries and in those hit hard by high energy costs.

The year-over-year profit increase for S&P; 500 companies is projected to be 10.3% in the first quarter, according to Thomson’s tally of analysts’ estimates. That would be the smallest gain since the second quarter of 2003.

What’s more, since the middle of last year many companies’ results haven’t been nearly as good as the overall S&P; 500 number would suggest. That’s because the figure has been inflated by massive profit gains at energy companies such as Exxon Mobil Corp. and Occidental Petroleum Corp., given record oil and natural gas prices.

Excluding energy companies, profit growth for S&P; 500 companies was 8.5% in the fourth quarter and is expected to be a modest 6% in the current quarter, according to Thomson.

By contrast, S&P; 500 earnings growth excluding energy firms was 11.2% in the first quarter of 2005.

“Companies are finding it increasingly difficult to post record earnings,” said Howard Silverblatt, a senior analyst at Standard & Poor’s in New York.

For one thing, the math gets tougher as an economic expansion ages, analysts note. For much of 2003 and 2004, earnings were rising more than 20% per quarter as results rebounded from the depressed levels of 2001 and 2002.

Deep cost cutting in the wake of the 2001 recession left companies with significant operating leverage that translated into huge profit gains when their sales began to rise again.

Although many firms continue to focus on cost cutting, their bottom lines are being pressured by higher expenses for energy and other raw materials.

A lot of companies “feel they need to raise prices,” said Ken Goldstein, an economist at the Conference Board, a business-funded research group in New York.

But that could be a tough proposition in some industries if consumer spending slows in the first half of this year, as many on Wall Street expect.

Analysts already have low expectations for first-quarter earnings growth in some consumer-dependent industries. Healthcare companies in the S&P; 500 are expected to post growth of just 3% this quarter, according to Thomson.

The gain is expected to be 4% in the consumer-staples sector, which includes manufacturers of household products and other small-ticket items.

Another weak spot: the basic materials sector, including chemical manufacturers. Earnings in that sector are expected to be down 7% this quarter from a year earlier as high raw materials prices continue to hurt the bottom line.

But some experts say analysts may be too pessimistic about first-half earnings growth. It still is hard to find signs that consumer spending has downshifted. And the Conference Board last week reported a sharp jump in January in its index of leading economic indicators, which is designed to forecast economic growth three to six months in the future.

“The latest rejuvenation of the leading indicators bodes well for profitability,” said John Lonski, economist at Moody’s Investors Service in New York.

In particular, a continued strong pace of business capital spending could be good news for companies in the technology and industrial sectors.

The tech companies in the S&P; 500 are expected to post profit growth of 15% this quarter, down slightly from the projected 17% growth of the fourth quarter, according to Thomson.

The industrial sector in the S&P; index is expected to show growth of 12% this quarter, down from 17% in the fourth quarter but still far ahead of anticipated growth in consumer sectors.

Even if the projected profit lull comes to pass in the first half, analysts are more bullish about earnings in the second half of the year. That may reflect widespread expectations for a peak in interest rates by midyear and for energy prices to calm down.

Analysts’ overall estimate for the S&P; 500 is for 14.9% growth in the third quarter and 12.8% in the fourth quarter, said John Butters, senior research analyst at Thomson in Boston.

The stock market appears to be buying into that second-half optimism, for the moment: The Dow Jones industrial average hit a 4 1/2 -year high last week and is up 3.2% year to date. The S&P; 500 index is up 3.3% this year; the Russell 2,000 index of smaller stocks is up 9.4% and closed at a record high on Friday.

Given relatively disappointing stock gains in 2005, when the S&P; index rose 3% for the full year, “I would argue that the market has already adjusted for a slowdown in earnings” in the near term, said Michael Metz, investment strategist at fund manager Oppenheimer Holdings in New York.