Monday, April 23, 2007

Baloney Ain’t Steak

Question: What do you get when you take out Energy and Financials from 1Q07 earnings?
Answer: -3.59%.

In the midst of the all the new-high excitement, a little piece of data seems to have slipped under the radar screen of many investors: mega cap has begun outperforming all other capitalization groups.

Since the start of earnings season, the mega cap S&P 100 is at the top of the performance food chain. In fact, the performance record since April 4th shows exactly the high to low quality performance one would expect in changing times: mega over large over mid over small over micro (see chart to the left and in report).

What could possibly explain this occurrence? Perhaps the answer lies in the information noted at the top of this report: when one widens the lens to the much larger market and breaks down the data into its component pieces, the 1Q07 earnings performance data paints a very different picture.

Let’s look at the facts.

Mega over large over mid over small over micro. (see chart to the left and in report)

Interestingly, this now matches the one-year performance data noted in last Thursday’s Special Report. (see chart in report)

I suspect the answer to this shift lies in the data compiled by the Wall Street Journal on the much larger and broader 769 companies that have reported thus far. As the tables and analysis on the next page show (see report), the broad market has produced the following data:

769 companies reported
Net on Continuing Operations +7.21%
Net Income +3.96%

Now, if one excludes two sectors – Financials and Energy – to get a better picture of economic performance, the results are as follows:

769 companies reported ex Financials & Energy
Net on Continuing Operations +0.55%
Net Income -3.59%

In regards to the Financials sector, a breakdown of the very solid numbers produced thus far shows that when you exclude the results from Wall Street oriented firms, the 15 - 16% growth in earnings is cut in half.

(To view all tables and charts, please see report)

Investment Strategy Implications

There are many reasons to explain why the equity markets around the world are making new highs, but an across the board strong 1Q07 earnings season is not one of them.

If mega and large cap represents the higher quality end of the food chain, then the lower end is producing a much less tasty meal. In other words, baloney ain’t steak.

(Note: To obtain access to all Blue Marble Research reports, please click on the Blue Marble Research Services to the left.)


Anonymous said...

Hi Vinny,
I am a daily reader of your blog and a huge fan of your book. Please make the graphs a bit larger or make them clickable so that viewers can see an enlarged popup of the charts. (Just a suggestion =)

Vinny Catalano, CFA said...

Thank you for the compliments.

I would like to make the charts on this blog more viewer friendly, but that's not possible as I cannot alter the template of this blog.

While this may sound like a plug for my research service, the only way to see the charts in larger form is to become a subscriber as they can be viewed more easily.