Earnings Growth Stalls As Economy Downshifts

Big companies saw a dramatic slowdown in profit growth during the final three months of 1995, with Wall Street expecting improvement to be little more than half the rate of just six months earlier.

The deceleration came as the economy’s “soft landing” took hold and the furious downsizing and cost-cutting of the past several years produced fewer and smaller gains. Stock prices surged to new highs during the quarter, but slack earnings could hurt future improvement.

Already, bad earnings news has hit some companies. Apple Computer has forecast a loss for the quarter and cellular phone maker Motorola turned in disappointing results, sending its stock plummeting.

Profits for companies comprising the S&P 500 stock index are expected to grow 11.1 percent in the fourth quarter, according to I/B/E/S Inc., a provider of earnings information. That compares with an 18.2 percent gain in the third quarter and 21.4 percent improvement in the second.

An even broader measure of profits, which looks at expectations for all 4,700-odd companies I/B/ E/S tracks, shows expected growth of 12.8 percent in the fourth quarter. All profit measures look at operating results, which exclude one-time factors like asset sales.

“We are declining in terms of earnings momentum, which is not surprising given the slowdown in overall economic activity and my belief that the best of the cost breaks are behind us,” said Stephen S. Roach, chief economist at Morgan Stanley & Co.

“At the same time,” he said, “I do not think this is a portent of outright declines in profitability.”

In fact, Wall Street analysts expect profit growth for the S&P 500 companies, a relatively consistent group of public corporations, to come in at 11.3 percent in the first quarter of 1996, a slight improvement from the final quarter of 1995.

Few who follow the economy and investments expressed surprise at the slowdown in fourth-quarter profit growth. The very idea behind the economic soft landing, engineered by the Federal Reserve with higher interest rates in 1994 and early 1995, was to keep economic growth moderate along with inflation.

Low inflation, however, can hinder the ability of corporations to charge more for their products and slower economic growth limits demand for companies’ goods and services. Both can damage the bottom line.

“This is exactly what you would expect to happen to earnings with growth slowing down,” said Peter J. Canelo, chief investment strategist at NatWest Securities Corp.

One reason corporate earnings were able to breach the 20 percent growth level, which they did for three straight quarters beginning with the final three months of 1994, was the relentless cost-cutting that has become de rigueur.

Shedding costly employees and redundant operations allowed companies to post sizable earnings gains despite little increase in demand for their goods and services.

Much of that cost savings, however, has already been attained and companies are finding there’s little excess left to cut. That suggests profit gains will have to come from somewhere else, like the development of new products and markets.

Such improvements may be difficult in a slow-growth economy.

On its face, the fourth-quarter earnings news appears a sign of bad times to come for the stock market, which is driven largely by corporate profit performance.

Investors, however, are more concerned with performance vs. expectations and analysts have been lowering their fourth-quarter forecasts almost across the board for the past several months. Thus, companies need only meet the more pessimistic expectations.

“Things have been slowing down all year - it hasn’t bothered this stock market,” Canelo said. Even with the slowing growth, some industry groups are expected to post strong gains.

Among the big winners expected to emerge are investment companies, with a gain projected at 141 percent, according to I/B/E/S. Basic metals producers, excluding steelmakers, should see earnings up 64 percent in the fourth quarter.

On the downside, automakers are expected to see earnings fall 41.6 percent and trucking companies should see a decline of 40.4 percent.