For investors, this restaurant chain is as hot asthe red chili salsa on its menus. Maybe hotter. Maybe too hot.
The stock of Chipotle Mexican Grill has climbed four-fold in five years, andfor good reason. Most quarters, the company would report surprisingly highearnings and investors would clamor to buy. But last month, the pattern broke.Chipotle posted blockbuster earnings, but investors sold.
The company's sin? It missed its target for revenues. The stock fell 21percent, from $404 to $317, in a day.
Chipotle is not alone. Six in 10 big companies reporting second-quarter resultshave missed revenue targets, according to FactSet, a financial data provider.That is the worst showing since the recession.
Companies meeting expectations aren't doing so well, either. Overall, companiesin the Standard & Poor's 500 are expected to have increased revenue 2percent in the second quarter, according to S&P Capital IQ. That is thelowest growth, outside of a recession, in more than nine years.
"Demand is drying up," says Michael Thompson, managing director ofS&P Capital IQ. "I'm worried. I'm very worried."
So are investors. On Wednesday, Priceline.com fell $117 to $562 after reportingrevenue that was lower than analysts had expected. The story has been the samefor dozens of companies across industries, from Coach, a luxury goods retailer,to Boston Scientific, which sells medical devices, to glass-container makerOwens-Illinois.
Revenue matters because it's a good path, though not the only one, to higherprofits. If you sell more, you will often earn more. Companies in the S&P500 index increased revenue 11 percent last year. That helped lift earnings 16percent to a record high.
But now companies are having trouble getting people to buymore. The U.S. economy grew at an annual pace of just 1.5 percent in theApril-June period. And growth abroad is faltering, too. Many of the 17countries that use the euro are in recession. Brazil and China are slowing. OnFriday, China reported that export growth slumped to 1 percent in July, downfrom 11 percent a month earlier.
For all the ominous news, most investors are still buying stocks. The S&P500 is up 11 percent so far this year. That is because in the end, all thatmatters is earnings, not revenue. And earnings, after barely rising in thesecond and third quarters, are supposed to explode.
Wall Street analysts who advise investors on stocks expect earnings to rise 10percent in the fourth quarter and 12 percent for all of 2013, according toS&P Capital IQ. But their expectations for revenues don't seem to jive withthe optimistic profit picture. Revenues are expected to rise only 3 percent inthe fourth quarter, then drop nearly 2 percent for all of 2013.
Economist Ed Yardeni, head of Yardeni Research, says he's hoping companies willpost higher revenue, but he doesn't think that's likely.
"If anything, they will surprise on earnings," he says, meaningearnings will come in lower than expected.
Previously when revenue has faltered, companies were able to cut costs tocompensate. They laid off workers, squeezed remaining staff and used technologyto run more efficiently. And U.S. companies have been pros at doing this, asthe millions of unemployed and all those people who do the work of twoemployees can attest.
The problem is, there's a limit to how much you can squeeze your workers anduse technology to produce more. And U.S. companies are just about as lean asany time in history.
U.S. companies are pulling nearly 9 cents of net income out of every dollar ofrevenue versus a three decade average of 7 cents or so. Yet the consensus amonganalysts is that this profit margin will jump to a record 9.6 cents per dollarnext year, according to Goldman Sachs.
In other words, companies will do even more with less.
Though that may seem unlikely, it is possible. Many economists did not expectU.S. companies could run so efficiently for so long. Typically in a recovery,profit margins snap back to their long-term average as companies spend more.But wages are barely growing. It also helps that interest rates are at recordlows. That means companies have been able to keep borrowing costs low.
But lately the signs haven't been good. On Wednesday, the government reportedU.S. companies squeezed more out of workers last quarter but less than average.Productivity, or output per hour worked, rose at an annual rate of 1.6 percentversus a 2.2 percent average since 1947. Larry Hatheway, chief economist atUBS, also notes that profit margins have been slipping lately, not rising asanalysts expected.
Hatheway is one of the few economists who think margins can stay abnormallyhigh. But even he's worried. His guess is that earnings will climb no higherthan 5 percent next year, less than half what analysts expect.
"You won't be able to grow earnings much faster than revenue," hesays. "Analysts will have to revise down their earnings."