3 Stocks Expected to Double Earnings Next Year

Fast earnings growth is a promising sign for a stock. Expectations of fast earnings growth, however, can cause trouble. A glowing forecast for next year's earnings often persuades investors to pay many times this year's earnings for shares. The result is often disappointment.

High-expectation stocks are more than twice as likely as humble-expectation ones to produce negative earnings surprises, and they tend to suffer much sharper price declines afterward, according to a 2002 study by a pair of University of Michigan finance professors.

The broad U.S. stock market faces high expectations at the moment. Companies in the S&P 500 index are forecast to improve their earnings by 34% next year — more than three year's worth of typical growth. Accordingly, the index is priced at 20 times this year's earnings forecast, about one-third richer than its historical average.

Below are three S&P 500 companies whose earnings per share are expected to double between their current fiscal year and their next one, ignoring one-time charges and credits. These companies aren't necessarily doomed to fall short. For each, the earnings increase would represent a step toward prior levels of profitability rather than a jump to record levels. But investors should nonetheless be careful not to pay too much for the presumed growth.

Bank of America's (BAC) stock price is 68% below where it stood at the end of bubbly 2006, but because of a much larger share count, its stock market value is down only 38%. Of course, included in that value are mortgage seller Countrywide and investment seller Merrill Lynch, both of which used to have plump market values of their own before falling into desperate financial condition and being bought by Bank of America last year. In the third quarter, Bank of America lost money, as revenue from credit cards, brokerage services, investment banking and mortgages declined from the second quarter. The company is expected to end the year with a profit. The consensus forecast for 2010 calls for a sharp improvement, but individual estimates within the consensus are broadly scattered, and for good reason. Much of the bank's profit recovery depends on the future ability of borrowers to make their payments, which in turn depends on difficult-to-predict factors like employment and the direction of asset prices.

So puny are Harley Davidson's (HOG) profits at the moment that they're expected to more than triple next year and still not amount to half what the company made in 2007. Management has a turnaround plan that, unfortunately for York, Pa., bike-builders involves shutting the company's plant there. Harley will also cut non-core, money-losing products like Buell and MV Augusta motorcycles, while adding more international dealerships for its core brand. A weak dollar seems likely to spur overseas purchases. The stock price has nearly tripled since March. Shares now seem priced as though an earnings recovery is a sure thing, at 21 times forecast 2010 earnings.

Masco (MAS) makes home-improvement products, like cabinets, faucets and paints. In 2006, its sales topped $12.7 billion. This year, they're expected to total about $7.6 billion, a 20% decline from last year. Profits are projected to be positive but skimpy this year and to multiply next year on a dash of sales growth and plenty of cost-cutting. On Tuesday, though, investors learned that September housing starts and building permits were much weaker than expected. Masco has worked to reduce the number of products it sells to builders of new houses, but the company still depends on them for about 35% of sales. Shares trade at 40 times the 2010 earnings consensus.