Focus on Positive Earnings:
As Economy Slows, Look Here for Earnings
NEW YORK -- Everybody on Wall Street wants sustainable earnings growth. But in a slowing economy, locating buoyant earnings isn't as easy as it sounds.
One time-tested strategy is to home in on companies whose products are in demand whether the economy soars or swoons. Drug companies, for instance, are expected to post solid profit gains of 15% in the third quarter, says Chuck Hill, research chief at First Call.
But not all so-called defensive stocks are made equally. Optimism is dimming for companies that sell can't-do-without products such as toothpaste, soap and food. Analysts have slashed projected profit growth for the third quarter to 7% from the 15% growth expected back on April 1. Not a good trend.
The best bet now might be to find where earnings momentum is greatest. So Joe Kalinowski at earnings-tracker I/B/E/S scanned his database for sectors that both beat earnings estimates handily the latest quarter and had their profit estimates increased for the rest of 2000. Six made the cut:
* Oil. Earnings estimates for fiscal 2000 have been revised upward by 2.4 percentage points the past month, and 12.4 percentage points the past three months. Expected 2000 earnings growth for the sector stands at 106%. Not surprisingly, many oil stocks have rallied sharply and are trading near 2000 highs.
Still, oil stocks, particularly oil-services firms, ''have more room to run,'' says Kurt Hallead, analyst at Merrill Lynch. Chalk it up to record crude oil prices and high demand. ''I have yet to find a sector (with) the same earnings growth momentum,'' he says.
* Gas utilities. Like gasoline, tight supplies of natural gas have translated into higher prices. Couple that with an expected jump in demand heading into the winter heating season, and the profit outlook remains robust, says Donato Eassey, analyst at Merrill Lynch. Shares of such companies as El Paso Energy and Enron have soared 50% to 100% this year. I/B/E/S says 2000 earnings estimates are up 3.5 percentage points the past month to 24.8%.
* Photo-optical equipment. Companies that make optical components for the likes of Nortel Networks, Lucent and JDS Uniphase are riding a massive wave. ''This is a brand new investment theme,'' says Mark FitzGerald, analyst at Banc of America Securities. ''The optical business is where the semiconductor business was 25 years ago.'' Last quarter, three out of four companies in the sector topped estimates. Analysts have raised 2000 estimates 1.9 percentage points in the past month to 62.4%, I/B/E/S says.
* Semiconductors. Chip stocks took a beating this summer as signs of slowing demand for cellphones were viewed by many as the end of the current cycle. Not to worry, says John Pitzer, analyst at CS First Boston. This is ''Year 2 of a three-year cyclical upturn,'' he says. Data suggest that demand for chips from the makers of personal computers, cellphones and other devices is picking up, he says. Analysts have raised their profit estimates almost 11 percentage points in the past three months and project 100% growth in 2000, I/B/E/S says.
* Investment firms. Brokerages like Salomon Bros. and Merrill Lynch are benefiting from a much-improved interest rate outlook and industry consolidation, says Joe Battipaglia at Gruntal. Analysts expect underwriting and trading fees to climb now that interest rates are stabilizing. Projected earnings growth has been revised up 1.5 points the past three months and is expected to hit 38%. Tuesday, Donaldson Lufkin & Jenrette soared 25% ahead of news it would be acquired by CS First Boston.
* Home builders. Despite rising rates last quarter, 13 of 15 companies topped earnings expectations. Estimates for the rest of the year have risen 2 percentage points the past month. Tuesday, the government reported that home sales surged in July, the biggest gain in more than seven years. Smith Barney analyst Stephen Kim says stocks in the group could see gains of 45% to 85% in the next 12 months. Kim says most are trading at five times their 12-month forward earnings, vs. 24 for the Standard & Poor's 500 index.
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