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Tuesday, July 13, 2010

Dow Futures Rise as Alcoa Trumps Portugal Cut

Alcoa Kicks-off Earning Growth Week
U.S. stock index futures pointed to a higher open Tuesday after Alcoa got earnings season off to a positive start by beating estimates. Positive sentiment overcame another debt downgrade for Europe.

European shares were higher, showing little reaction after Moody's cut Portugal's rating by two notches to A1. Also in Europe, Greece managed to sell $2.03 billion of 6-month T-bills, but had to pay a higher yield compared to the April auction. Asian shares ended mostly lower with Shanghai stocks dragging on the region.

Heading into earnings

As we head into earnings, if your strategy is buying into analyst estimates—this tip and reminder: Estimates are based on assumptions that generally are used to justify stock price targets.

There’s no standardization of what goes into assumptions, which means there is no guarantee the assumptions won’t be flawed.

The analyst’s assumption, according to the report, were based on a “weighted blend of EV/EBITDA an P/E (price-to-earnings) scenarios utilizing historical peak/trough multiples.”

That’s just one of any number of ways to value a company. And it assumes that the price/earnings multiple will expand, and not just by a small amount: From around 15.7-times today to—worst case, according to the analyst—20-times forward earnings. (And this is in the world of tech, where the average P/E is closer to around 10.) Never mind that the analyst’s target is nearly a year-and-a-half away—enough time for anything to get in the way of the assumptions; or that P/Es tend to contract over time—not expand; or that the law of large numbers will kick in, especially after Apple’s spectacular performance.

More importantly: Anything can happen between here and there, including a disappointment—yes, even with a company like Apple. Apple, in due course, will be no exception. Based on Apple’s short-interest, which is at the lowest rung of any S&P 500 or Russell 1,000 company, most investors don’t expect that to happen any time soon.

Put another way, virtually nobody is on the other side of the Apple trade.

The blended earnings growth rate (estimated & reported) for the S&P 500 for Q2 2010 is 27% versus an estimated earnings growth rate of 25.2% for Q3 2010.
As of April 1st, the earnings growth rate was at 23%. Of the 26 (5%) S&P 500 companies who have reported Q4 results, 69% beat estimates, 15% were in-line, and 15% were below estimates.

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