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By Jason Stipp | 07-12-2012 04:00 PM

Is the Earnings Bar Set Too Low?

Sanibel Captiva's Pat Dorsey addresses weakened earnings expectations for the quarter, Europe's effect on stock prices, and a tech name worth watching.

Note: Pat Dorsey is the former director of equity research at Morningstar. He is now the president of Sanibel Captiva Investment Advisers.

Jason Stipp: I'm Jason Stipp for Morningstar. We're on the brink of earnings season, and we hope we'll have something more to read about than just the Spanish bond yield over the coming weeks. But is the cloud of pessimism over earnings really merited? Here with me to discuss is Pat Dorsey, president of Sanibel Captiva Investment Advisers.

Pat, thanks for being here.

Pat Dorsey: Happy to be here, Mr. Stipp.

Stipp: It seems like before every earnings season over the last couple of years, folks have been fretting, hand-wringing over earnings, [fearing] they are not going to meet expectations, and that we're going to finally see earnings start to falter after several quarters of strong business performance. It feels like the same thing again this time around. Do you feel like we're wringing our hands again, and we'll see actually a surprise from earnings?

Dorsey: Well, it certainly not going to be an upside surprise in terms of the results. I mean, the macro environment is definitely less pleasant than it was a few quarters ago. But the question becomes then, "What is discounted? What are the expectations?" Last I checked the expectations for aggregate earnings growth for the S&P 500 are either down 1% or up 2% or something mild like that. It's a low bar, I would argue, and you've got individual firms priced at 10 times free cash flow. I would argue that a lot of this uncertainty is well-discounted in equity prices.

Stipp: It's not like we've seen stocks running up in the past few weeks; in fact [it's been] quite the opposite.

Dorsey: Exactly. The only places you've had stocks running up are basically anything not tied to Europe. I think there is anything-but-Europe trade going on right now. So you see Costco. You see Chipotle. You see basically a lot of companies tied to U.S. consumer spending at, frankly, very high multiples.

Stipp: I want to touch on some of those areas of vulnerability in a moment, but one area I think that folks have been worried about is the technology space and concerns about some slowdowns there. What's your take on that particular sector? Do you think we'll see some more extreme weakness in technology than in other areas?

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