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Amid Profit Worries, Investors Pay Closer Attention to Sales


NEW YORK — Midway through another closely watched corporate earnings season, investors continue to punish companies that post disappointing numbers. But this time, a major focus is on revenue growth.

Top-line, or revenue, growth obviously is a key determinant of profits, and it also is a leading indicator of the economy's direction. Weakness in third-quarter sales growth across a wide range of industries has helped build the consensus that the U.S. economy is cooling.

"The first thing to go is always the top line," said Steven M. Frenkel, market strategist at Ladenburg Thalmann & Co.

Some technology firms, including Apple Computer, Conexant Systems and Texas Instruments, have either reported weaker third-quarter sales or warned of sales weakness in the fourth quarter--a strong reason their stocks have been crushed in recent weeks, dragging the broad market lower.

Overall, some degree of slowing sales is welcome on Wall Street, given the market's fear of inflation and the Federal Reserve. But when it comes to individual companies, investors have shown they are intolerant of disappointment--as retailer Circuit City demonstrated Friday, when it warned that poor sales would mean a third-quarter loss.

So far, with about half of the blue chip Standard & Poor's 500 index companies reporting earnings, third-quarter results are up an average of 16.4% from a year ago, according to First Call/Thomson Financial.

Energy, technology and health-care companies have posted the strongest results.

But S&P 500 earnings growth is down from 21.6% in the second quarter. And in a sign that analysts expect the slowdown to continue, Wall Street is now projecting earnings growth of 13.9% in the fourth quarter, according to First Call.

As sales weaken, more companies have begun cutting costs aggressively to try to bolster profits.

Among big industrial firms, Textron, Ingersoll-Rand and Georgia-Pacific recently announced major layoffs and plant closings as sales have skidded and their stocks languish near multiyear lows.

The Chicago outplacement firm of Challenger Gray & Christmas said announced layoffs in the third quarter picked up sharply from the moderate levels of the first half of the year. Nearly 170,000 job cuts were announced from July through September, compared with only 81,000 from April through June. Year-to-date through September, however, layoffs are down 30% from last year.

"When business drops nowadays, companies don't wait," Chief Executive John Challenger said Friday. "They pacify Wall Street by showing they're taking action to get their costs in line."

Indeed, the cost side of the equation is being scrutinized by investors as critically as sales growth. The rising costs of oil, wages and employee benefits are showing up in many earnings reports.

Home Depot shares dropped 29% on Oct. 12 after the company warned that its profit would fall short of expectations in the second half of the year, partly because the home-improvement retailer was getting squeezed by higher energy costs.

"Eighty percent of U.S. companies transport by truck," said Tony Crescenzi, bond-market strategist at Miller Tabak Hirsch & Co. in New York. "Whether you sell paper or dog food, you're going to get charged more."

Crescenzi was alarmed recently when the California Public Employees' Retirement System had to swallow a 9% increase in health-insurance rates.

"There's a bit of a stagflation feel to the numbers," Crescenzi said, raising the specter of the low-growth, high-inflation misery that dogged the U.S. economy in the mid-1970s.

At the same time, however, Crescenzi noted that the economy is in much better shape than it was in 1989, when it was on the brink of the last recession.

Some stock market watchers believe that the bounce-back in the last three trading sessions of this week may signal not only a turn in the market, but that investors are coming back to the view that an economic soft landing is more likely than recession, generally defined as two consecutive quarters of negative economic growth.

Lehman Bros. strategist Jeff Applegate thinks overall economic growth is slowing from 5%-plus annually to 4% or so, while corporate earnings will turn in gains of 12% to 13% next year--robust, though well down from their 18% to 20% peaks.

Beyond the headline numbers such as sales and profit growth, investors in the current skeptical environment are looking more closely at companies' profit margins and things like inventories, receivables and nonrecurring gains.

Purchase, N.Y., money manager Robert Olstein, a stickler for earnings "quality," said he is amazed by Wall Street's newfound rigor.

When the market was booming late last year and early this year, nobody seemed to mind that, for example, telecommunications-equipment companies were inflating sales by offering easy financing terms to fledgling Internet companies.

When the "dot-com" crash came, it caused uncollectible receivables to balloon on the books of many such suppliers, Olstein said.

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