3 companies likely to double profits

By SmartMoney

Fast earnings growth is a promising sign for a stock. Expectations for fast earnings growth, however, can cause trouble. A glowing forecast for next year's earnings often lures 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 Standard & Poor's 500 Index ($INX) are forecast to improve their earnings by 34% next year -- more than three years' 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.

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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

Bank of America's (BAC, news, msgs) 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 they fell into desperate financial condition and were 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 will depend 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.

Harley-Davidson

So puny is Harley-Davidson's (HOG, news, msgs) profit at the moment that it's expected to more than triple next year and still not amount to half of 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 noncore, money-losing products such as 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

Masco (MAS, news, msgs) makes home-improvement products, such as 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. Profit is projected to be positive but skimpy this year and to multiply next year on a dash of sales growth and plenty of cost cutting.

Masco has worked to reduce the number of products it sells to builders of houses, but the company still depends on them for about 35% of sales. Shares trade at 40 times the 2010 earnings consensus.

This article was reported by Jack Hough for SmartMoney.