Why Earnings Growth Has Slowed as Economy Recovers

The single greatest mystery of the fourth-quarter 2011 earnings season is why EPS growth will slow despite what is probably the most promising part of the recovery since the recent deep recession. That is due to the fact that companies have run out of expense cuts, as well as to the trouble in Europe, and to a nearly unprecedented period of poor management at America’s largest corporations.

By most estimates, improvement in Standard & Poor’s 500 earnings growth stumbled in the fourth quarter. S&P 500 Index companies may have earned just $24.74 a share in the quarter, according to analysts’ estimates compiled by Bloomberg as of January 6. That is worse than in any period since the September 2009 quarter.

Unemployment rose sharply from late 2007 through 2009, and in some quarters, since 2010. Most estimates put total jobs lost at eight million in America. The losses were spread broadly. Government statistics show that unemployment rose in 45 of the 50 states. Some of the “downsizing” occurred at small companies caught in cash squeezes. Data from research firms like Challenger Gray show that the America’s largest companies were busy firing as well.

As far as senior management at S&P 500 companies are concerned, all good things must come to an end. Downsizing has reached its limits at many firms as the productivity of those workers left is stretched to the maximum. Earnings can no longer be enhanced by traditional cost cuts.

Any argument that the U.S. economy has become decoupled from Europe’s is false, at least as far as American company earnings are concerned. Corporations from Intel (NASDAQ: INTC) to General Motors (NYSE: GM) say they face earnings problems in Europe. And, by extension, China has been affected because of its reliance on exports to Europe. Profits from overseas operations will not bolster S&P 500 bottom lines in either Europe or Asia.

Poor management was abundant in the last part of 2011. The was true particularly at very big companies like Cisco (NASDAQ: CSCO), Hewlett-Packard (NASDAQ: HPQ), Avon (NYSE: AVP), Eastman Kodak (NYSE: EK) and Macy’s (NYSE:M). It was also abundant at emerging firms like Netflix (NASDAQ: NFLX).

Those things that caused poor earnings growth in the final quarter of 2011 have not gone away. Some, like the trouble in Europe and the loss of ability to downsize further, will not go away. The start of 2012 will be just as tough for earnings growth as the end of last year.

Douglas A. McIntyre