As Companies Beat Estimates in 2011, Expect Stocks to Soar

As Companies Beat Estimates in 2011, Expect Stocks to Soar
As Companies Beat Estimates in 2011, Expect Stocks to Soar

Cost-cutting helped businesses set record profits in 2010, but what will companies do to spur the value of their shares upward in 2011? The answer is, attempt to build sales faster than expected on a lower-cost base -- and that's a recipe for explosive profits. According to Bloomberg, 72% of S&P 500 companies beat their sales-growth estimates by an average of 2.3% in the fourth quarter of 2010.

If that trend continues or strengthens in 2011, those companies are likely to exceed revenue and profit expectations. That's partially because consumer spending, which accounts for the bulk of GDP, exceeded expectations in 2010 by rising 0.7%. Stocks have surged 94% since the markets hit their March 2009 lows, setting a growth record not seen since 1936, according to S&P's Howard Silverblatt.

But was that torrid pace setting the stage for the double-dip that some have predicted, or for a rosier stock market in 2011? In my view, it's the latter: I think stocks look cheap relative to their earnings growth and historical valuations.

If Bloomberg is to be believed, S&P 500 companies will grow faster in 2011 than they did in 2010. It estimates that total revenue for S&P 500 companies could rise by much as 7.5% in 2011 -- the most since 2007 -- to a record high of $1,017.44 a share. This is a remarkable turnaround from the depths of the financial crisis. Between November 2008 and October 2009, sales for those companies plunged 13%.

Don't Buy Dr. Doom's Dreary Predictions

But while all is well for corporations -- which earned record profits of $1.66 trillion in 2010 and piled up record cash balances of nearly $2 trillion -- things are far from rosy for American workers. On Feb. 4, the Labor Department reported that a mere 36,000 new jobs were created even as the unemployment rate plunged to 9% from 9.4%. After a 2.6% rise in productivity in 2010 -- the sharpest jump since 2002 -- and a 1.5% drop in wages during the fourth quarter, it should come as no surprise that companies are boosting their operating margins -- to a near-record 19.8% -- by squeezing workers.

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All this good news for Corporate America seems to have been drowned out by the double-dip prognosticators. Among these, none is more prominent than New York University's Nouriel Roubini, who enjoyed his star turn when the media gave him credit for predicting the financial crisis. Although the economy appears to have recovered, Roubini seems to be looking for more dark clouds. As recently as Jan. 26, he warned of a double-dip recession in Europe's weaker countries. And he continues to harp on America's structural problems -- code for high debt and budget deficits.

So, should you worry about these structural deficits and shun stocks? If you do, you should pile into gold, which has lost some altitude recently. (The Standard & Poor's GSCI Precious Metals Index tumbled 6.5% in January, the most for the month since 1991.)

But stocks look like a better bet to me. Based on their P/E of 13.4 on 2011 forecasts of $97.50 a share according to JPMorgan Chase (JPM), stocks are cheap relative to their historical average of 15.8.

And with a combination of high operating margins -- meaning lower costs -- and a near-record revenue growth, the odds of positive earnings surprises and hence higher stock prices seem high. If you're worried that the near-zero rates of return offered by money-market funds won't earn you enough cash for retirement, now may be the time to shift into a low-cost S&P 500 index fund.