NEW YORK (CNN/Money) -
Yes, corporate earnings are on the mend. But their recovery isn't quite as strong as it appears at first blush.
Second-quarter profits of companies in the S&P 500 that had posted results through Thursday, according to Merrill Lynch, were up 7.5 percent versus last year. Another good quarter, building on the strong first-quarter.
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Justin Lahart, senior writer at CNN/Money, talks about second-quarter earnings and why they might not be as strong as they first appear.
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But Merrill economist Ron Wexler took a harder look at earnings and they didn't seem nearly as good.
First off, Wexler pointed out that much of the surge in earnings came from financial companies, a big S&P component that saw profits grow by a whopping 24.6 percent. The financials blew past analyst estimates thanks, in large part, to the low interest rates that prevailed through the second quarter and the surge in mortgage activity that ensued.
With rates up and mortgage activity having fallen to a one-year low, nobody expects a repeat performance. The banks need traditional consumer and business loan activity to pick up now. At this early stage of economic recovery, that hasn't really happened yet.
Take away those bank earnings and what do you get? Not much -- earnings through Thursday were up by just 1.1 percent over a year ago. With retailers reporting now, that will probably bump up to nearly 3 percent. No great shakes.
Taking it a step further, Wexler looked through all the income statements, balance sheets and cash flow statements for S&P 500 constituents and found that non-operational line items -- that is, revenues and costs not associated with the production of goods and services -- played a big role in driving profits. Cash flows from operations are only up 2.8 percent since the fourth quarter of 2001.
The news wasn't all bad. Companies are running quite lean, which means that they are well positioned to see a jump in profits as the economy improves and demand returns. But this really hasn't happened yet, which means that they will likely be slow to hire and slow to boost spending on equipment. That could mean the economy won't be so strong coming off the blocks as in the past.
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