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5 Stocks With Rising Profit Estimates

The Great Corporate Profit Rebound of 2009 is looking, well, not so great.

In November, this column <a href=”http://www.smartmoney.com/investing/stock tickers/Take-Profit-Estimates-With-Grain-of-Salt/”>warned readers to view skeptically Wall Street’s forecasts for 2009. Analysts at the time expected profits underlying the S&P 500 index to finish the year 17% lower but jump 30% this year. In fact, 2008 profits fell 40%. That should have made a big percentage increase this year all the more attainable.

But calls for that 30% profit jump this year were soon tempered to 24%, then 20%. Now, after a mostly disappointing first quarter, the forecast stands at 9%. Don’t be surprised if even that proves too rosy.

Blame Wall Street’s flubbed estimates on a pair of mental stumbling blocks that behavioral finance researchers call recency bias and anchoring bias. They’re loosely related. People tend to view events that are recent as normal, even when farther-looking historical data say otherwise. They thus often anchor their beliefs in arbitrary benchmarks, not realizing those benchmarks are skewed.

Late last year, analysts might have expected earnings to quickly bounce back to “normal.” Their beliefs were still anchored in the “golden age of profitability,” as one investment firm called 2006. That year, profits reached their highest share of the economy since the 1960s, while incomes lagged, as consumers shopped on borrowed funds made plentiful by bloated house prices. All factors involved — house prices, consumer spending, corporate profits as a percentage of gross domestic product — have since reverted to, or at least toward, their long-term averages. Slowly, Wall Street seems to be getting used to the idea that today’s lower level of profits represents a reset, not a temporary lull. In fairness, a rash of layoffs at investment firms means analysts are dividing their coverage time among more stock tickers, which might also explain why estimates took so long to fall.

If profits are now normal, stock ticker prices seem a touch high. Shares are 17 or 18 times earnings, depending on whether earnings grow 9% or not at all this year. Something closer to 15 or 16 times forward earnings would be more in keeping with history, and prices have languished at much lower levels following bubbles.

Recency and anchoring biases can help investors make money, too. Just as analysts are slow to fully acknowledge bad news, they’re slow to adjust for good news. That’s why studies have long shown that when earnings forecasts for a company are lifted, they’re more likely than not to rise again soon. There’s a shortage of upward earnings revisions at the moment, but there are some. Within the S&P 500, I count 67 companies whose current-year estimates have been raised over the past week, vs. 95 whose estimates have been lowered. Scan the first lot for valuations that still look modest and the results are few, but worth a look. Below I’ve listed five names.

Screen Survivors
Company Name stock ticker Ticker Industry Share Price Price Change YTD (%) Forward P/E (Curr. Yr.) Yield (%)
Data as of May 21, 2009
Burlington Northern Santa Fe BNI Railroads 67.5 -11 13 2.4
El Paso EP Oil & Gas Pipelines 8.8 12 8 2.3
Hewlett-Packard HPQ Computers 34.22 -6 9 0.9
Public Storage PSA REIT 64.36 -19 13 3.4
Sherwin-Williams SHW Chemicals 54.83 -8 15 2.6

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