I hate the green shoots metaphor, but I'll use it anyway. And I worry that we'll start hearing it a lot again: earnings season is underway on Wall Street and quarterly numbers are largely looking better than expected. Should we pop the champagne? I wouldn't yet.
Costs Or Revenue?
Did higher revenues or lower costs cause better-than-expected earnings? Let's take a company that hits close to home: Gannet -- the largest U.S. newspaper publisher. Oddly enough, they beat earnings estimates. If the newspaper market is doing better, that's gotta be a great sign for the economy, right? Sure, if that were the case. It isn't.
Bloomberg reports that second-quarter earnings were 46 cents per share, better than analyst estimates of 38 cents per share. But then it explains why:
Gannett implemented its second week of unpaid leave this year during the quarter to save money in an advertising slump. The leaves, combined with declining newsprint costs, helped cut operating expenses by 67 percent to $1.27 billion. Gannett also halted print publication of the Tucson Citizen and announced salary cuts of as much as 6 percent for its broadcasting unit.
Gannet's earnings were better because it cut costs -- not because it had more revenue. In fact, the article says that revenues declined 18%. Until revenues actually start increasing, it's hardly time to say that the economy is on the mend. Sure, profit margins might be better than expected, but unless they're wildly better, it's unlikely that firms laying people off or cutting workers' pay are likely to begin hiring again.
How Bad Is Better?
How bad were expectations? If you expect utter failure, but only get partial failure, is that reason to celebrate? Case-in-point: aluminum producer Alcoa's earnings. As the Chicago Tribune reported:
Pittsburgh-based Alcoa's quarterly loss amounted to 47 cents per share. A year earlier, the company earned $546 million, or 66 cents per share. The loss excluding items was 26 cents a share; analysts had projected a 38-cent loss.
So instead of 38 cents per share, Alcoa only lost 26 cents per share. That not terrible news, but I have a hard time calling it good. In fact, it's still pretty bad. Instead of proving that the economy is on the mend, this merely proves that analysts are a little too pessimistic, but clearly not entirely off-base.
The Recipe For Success
What factors led to the success? Take Goldman Sachs for example. As Megan noted yesterday, they had a great quarter. I didn't find this that surprising, because I think Goldman could probably even find a way to profit off being held up at gunpoint. Still, given how badly banks are said to have been doing lately, their earnings seem somewhat remarkable. Megan explains the likely reason for their triumph:
This is not actually hugely surprising, given that three of their biggest competitors went out of business or were acquired in the last year; as financial markets unfroze, Goldman, which had one of the cleanest balance sheets, was bound to see a hefty increase in their profits.
Exactly. They did not profit because of growth in the economy, better consumer confidence or some other green shoot-like phenomenon. They did well due to the quality of their brand and less competition. Again, this is not good news for the larger economy, just for Goldman and other banks with a solid brand name that will benefit from less competition.
What I've always found wacky about the stock market is that expectations are really all that matter. While there's certainly some legitimate joy to be derived by finding out that things might not be quite as bad as we thought, that's different from saying that they're good, or getting better. Certainly, earnings beating expectations is not a bad thing, but it's important to take these numbers with a grain of salt, while considering the context of the broader economy.