Stocks Sink As Poor Sales Add to Investor Worries

At first glance, the receding recession has been good to Goodyear. The tire company earned $72 million in the third quarter, more than double what it made a year ago. But missing from Goodyear's good quarter was one aspect of business health: Sales growth. Revenue at the tire company fell nearly $800 million in the third quarter. (See pictures of the top 10 scared stock traders.)

Goodyear has plenty of company. Driven by layoffs and other forms of cost cutting, more and more companies are boosting bottom lines at a time when sales are still faltering. That's starting to spook investors, who just a few weeks ago had seemed certain that corporate America had put the recession in its rear view mirror. The Dow Jones Industrial Average tumbled 250 points on Friday, in part because of worries that earnings puffed up by cost cutting could soon deflate.

"It's unusual," says Howard Silverblatt of Standard & Poor's. "Usually there tends to a strong correlation between sales and earnings."

Of the 117 companies in the S&P 500 that have reported rising earnings for the third quarter, 67, or nearly 60%, had a drop in sales. Indeed, companies from all types of industries were able to pull off the profit trick. Among the earnings winners and sales losers were big bank Citigroup, sneaker giant Nike and internet company Yahoo. (See 25 people to blame for the financial crisis.)

What's more, the divide between sales and earnings is about to get much bigger. Stock market research firm Zacks predicts that corporate earnings will rise an astounding 60% in the fourth quarter. Sales not so much: Up a mere 4%. "Earnings have been flaky to say the least," says top market strategist Ed Yardeni.

Of course it is normal for profits to rise faster than sales at the beginning of a recovery. And some see this as a sign that the recession is indeed over. "People have made a big deal about the fact that this is just cost cutting," says James Paulson, chief investment strategist of Wells Capital Management. "But that's always the fact when you pull out of a recession. I see a lot of similarities to other recoveries."

Profit margins are the business measurement of how much money a company makes on its sales. The math for the most basic measure is earnings divided by sales. And it's normal for profit margins to rise at the beginning of a recovery, as they are now, because companies cut cost and workers throughout the recession, making sales more profitable.

But what has some investors nervous is the speed at which margins have improved. Companies can only cut so much. And the early bulge in profit margins may be a sign that layoffs and other measure as a means of boosting the bottom line are coming to an end. Overall, S&P estimates that corporate profit margins averaged 7.8% in the third quarter. That's certainly not a record. But it is higher than the 15- year average of 6.6%.

"It's definitely a concern for earnings that sales are down," says Dirk Van Dijk, who is chief equity strategist for Zack's Investment Research. "There's a limit to the amount of cutting you can do."

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