Why These Two Big Company Earnings Reports Concern Me So Much

by Profit Confidential
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“The company beat on earnings but missed on revenues”—that’s the story this past earning season, and a similar one to the last few quarters.

It’s a real problem. Corporations are squeezing expenses and employee productivity without investing in new operations. Excess cash is being returned to shareholders in a zero-growth environment, peppered with some price inflation. This is not the recipe for a rising stock market.

So many companies beat on one financial metric, but missed on another. And DENTSPLY International Inc. (XRAY), a well-known dental supply company, is no exception; a stable and profitable business, DENSTPLY, like so many others, has hit a wall in terms of growth.

According to the company, its second-quarter sales were $761 million, down slightly from sales of $763 million in the same quarter last year. Earnings grew to $87.2 million, or $0.60 per diluted share, up from comparable earnings of $80.8 million, or $0.56 per diluted share. Adjusted earnings grew seven percent to a record $0.66 per diluted share.

The company cited its European operations and currency translation as reasons for the zero top-line growth. Management revised its adjusted earnings-per-share (EPS) range for 2013 slightly lower to between $2.33 and $2.38 per share.

All in all, DENTSPLY is a good business that sells to well-heeled customers. But generating meaningful sales growth is proving very difficult, and it’s tough to make a case for investing in a company that isn’t growing both its revenues and earnings.

Investor sentiment in the equity market is a perpetual balancing act. The market will forgive underperformance in earnings if a company is experiencing strong sales; the opposite is true when revenues come in flat, but earnings surprise.

But this financial dynamic is not sustainable over time. While the liquidity in capital markets remains decent, the goal of generating real economic growth (over inflation) is not being achieved. If artificially low interest rates along the entire yield curve were meant to help jumpstart the U.S. economy, the result has only been stabilization, not growth. (See “Why Corporate Earnings Are Taking a Back Seat to the Fed.”)

In the end, improving balance sheets at the corporate and individual levels will serve the long-term interest of the economy. But presently, monetary policy has proven not to be enough on its own to kick-start the economy over the rate of inflation.

Getting corporations to invest their cash hoard is going to be very difficult. They require continued certainty and an above-average return on investment. Without the opportunity, it’s just easier to offer more dividends and/or buy back shares.

Many second-quarter earnings reports offered some growth in one financial metric. In a lot of cases, sales growth was just price inflation, which the marketplace is absorbing.

The absence of any real top-line growth will start to hurt earnings, and the upcoming third quarter should see this scenario unfold. It is, therefore, a tough case to be a buyer of equities at this particular time.

Weaker outlooks from companies like Wal-Mart Stores, Inc. (WMT) and Cisco Systems, Inc. (CSCO) are the canary in the coal mine. My outlook for the third quarter is definitely diminishing.

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