Battipaglia's Bullish Outlook

07/02/2004 12:00 am EST


Joe Battipaglia

Market Strategist-Private Client Group, Stifel Nicolaus

"Second quarter earnings season should be a blowout," says Joe Battipaglia, one of Wall Street’s most popular and well-known analysts. The chief investment officer for Ryan, Beck & Co. notes, "Expect meaningful upside surprises." Here he explains his latest outlook.

"The bull case for equities is still intact. We have made the case repeatedly that the stock market can weather what the Fed has in store since earnings exert a more powerful force on valuations and prices. While it is well understood that profits grow at 7-8% annually over the long haul, the current crop of earnings reports are likely to be among the best recorded growth rates in corporate profitability in many years. First Call’s research group notes that the same analysts that have underestimated the profit recovery thus far are now scrambling to raise estimates ahead of the reporting season. Part of the reason for the optimism is the relatively few warnings companies are issuing about their coming earnings releases compared to those companies who have said publicly that they expect to meet or exceed estimated earnings. According to the First Call team, the ‘abundance of good news’ has led to the highest upward revision to S&P 500 earnings estimates in any quarter they have ever tracked. While analysts are expecting 20.3% growth in earnings for the quarter, First Call guesses that the growth number may land closer to 26% when all is said and done.

"This all should be placed in a broader context, however. S&P 500 operating earnings forecast by analysts are expected to reach $65.71 for the full year 2004 and $72 in 2005. Compared to $39 in trough 2001 earnings, this year’s estimated figure represents a 68% increase over three years. We are pleased to see a return to profitability supported by very healthy fundamentals. Businesses have emerged from the business downturn with more cash on hand and lower debts as a percentage of net worth. Today cash balances for non-farm corporate businesses exceed $966 billion compared to $795 billion at the height of economic activity in 2000. Debt, while higher in nominal terms, has been refinanced at cheaper average rates with longer maturities. Relative to net worth, debt levels have fallen from 73% of net worth in 1998 to 65% today.

"The improved balance sheet is also supported by strong cash flows, which are rising and are at an annualized rate of $374 billion through the first quarter. We expect that in order to replace the depleting capital base and remain competitive, that corporations will continue to spend from cash flow on capital expenditures and earnings will likely come under some pressure from accelerating wage pressure. Naturally, these facts should not be seen as negatives but as part and parcel of an economy that is returning to a state of expansion following several years of anemic growth as it relates to investment in human and physical capital. In fact, the acceleration of personal income growth from 2-3% per annum to nearly 6% in the last 12 months adds roughly $225 billion in additional spending with the conservative assumption that individuals spend at least 80% of income. This should go a long way to offset a modest increase in interest rates and diminished mortgage refinancing activity. The S&P 500 is currently trading at 16.5 times our next twelve month’s earnings estimate. For now, we are maintaining our year-end S&P 500 price target of 1,180 with a ‘rolling 12 month’ forward target of 1,300 which is reasonable within the confines of our discipline."

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