* Cost cutting helps firms to beat Q2 profit estimates
* Further savings hard to achieve, focus on revenue growth
* Return to growth in some G7 countries will help sales
By Dominic Lau and Atul Prakash
LONDON, Aug 20 (Reuters) - A sputtering European stock market rally needs a spark from clear signs of an economic recovery because companies are running out of costs to cut and will depend on sales growth to lift profits.
Analysts say that the prospects of revenue growth are improving after regional powerhouse Germany pulled out of recession in the second quarter, but caution that any hiccup on this front could dent stock markets.
European shares have jumped 46 percent from March lows, underpinned by better-than-feared corporate results.
The rally is showing some signs of fatigue with investors concerned about the quality of earnings after many companies missed revenue forecasts, but help could be at hand from gradually recovering economies.
"We are constructive on earnings but not because companies will do another massive round of cost cutting. We think there is basically some topline growth that will start to come back," said Nick Nelson, European equity strategist at UBS.
"Our view is that from the macroeconomic perspective, all the major economies will be showing positive quarter-on-quarter growth by Q3."
France and Japan also returned to growth in April-June. And a survey showed confidence in German economic outlook hit its highest level in more than three years in August.
Ronan Carr, Morgan Stanley's European equity strategist, expected revenue growth to track improving economic data.
"The topline recovery will lag. But it could start to show up in the second half of the year, given that GDP are starting to turn positive already," he said.
The investment bank had revised its European corporate earnings forecasts for 2010 to a rise in profits of 20 percent from no growth previously. For 2009, Morgan Stanley forecast a 20 percent fall in earnings.
More than half of the 219 DJ STOXX 600 companies that have so far reported second-quarter results beat expectations, according to Thomson Reuters data, though profit estimates were already low.
Companies are likely to avoid cutting jobs and capital expenditure further because they want to keep some firepower for the upturn when it comes, meaning that stock performance hinges on improved sales.
RECOVERY RISK
Mark Bon, fund manager at Canada Life, said he expected European earnings to grow by 2 to 3 percent in the third quarter, and by a similar percentage in the fourth quarter.
"Expectations of earnings are starting to recover," he said.
"There is still room for some positive surprises. The main risk at the moment is ... the pace of economic recovery. If there is a slight hiccup, it would be because the recovery seems to be coming through slowly."
Although three G7 countries were technically out of recession, U.S. consumers' gloom deepened in early August as a growing number of people in the world's largest economy fretted about their finances, spurring a retreat in equity market.
The International Monetary Fund's Chief Economist Olivier Blanchard also said the turnaround would not be simple as the crisis had "left deep scars, which will affect both supply and demand for many years to come."
Some analysts say the picture is too mixed to predict a return to strong revenue growth.
"The jury is still out. We are not seeing (strong second-quarter results) ripping through into the forward earnings estimates," said Philip Lawlor, chief portfolio strategist at Nomura.
"If you believe that this second-quarter was good, you would have seen people stepping up to the plate and starting to upgrade their forward earnings estimates," he said. "We have not seen any evidence of that yet."
Forward earnings per share for MSCI world equity stood at $18.47, down from $18.65 at the end of last month but up from $17.7 in the beginning of July before companies reported their second quarter results, Thomson Reuters data showed.
But for markets that have been roiled by uncertainty over the past two years, even a steady third quarter will be a satisfactory result.
"People are still talking about the third quarter... probably going to be an improvement but not a big improvement yet. So I don't think people will get too upset if the third quarter numbers are not particularly better than they were in the second quarter," Canada Life's Bon said.
One positive factor for equities is that a lower base for comparison would help companies to achieve positive third-quarter figures.
"In general, the third quarter last year became very difficult, so (it will be) easy to beat them this year," said Dean Tenerelli, portfolio manager for European equities at T. Rowe Price International.
"Third-quarter will be OK to slightly upgraded."
(Editing by Sitaraman Shankar)