Earnings Estimates Are Wild Guesses, But Still Swinging Stocks
(Bloomberg) -- Analysts may have struggled to predict the impact of coronavirus on corporate results but old habits are hard to break in the stock market and their forecasts are, as usual, driving reactions to earnings reports.
With nothing better to go by, investors are rewarding companies that beat predictions and punishing those that miss. Corporate profits have been dire, with some companies seeing earnings drop more than 50%, but what’s mattered more for stock prices has been how they’ve stacked up to forecasts.
Jumpy markets are making the gains and losses bigger than usual but the overall pattern is intact, contrary to some expectations. With the first week of the earnings season nearly in the books, companies that beat on both sales and profits have outperformed the market by 2.2%, more than the historical average of 1.6%, according to Credit Suisse. Those that missed both measures have taken a hit of 4.8%, a full percentage point more than what’s usual. Depending on how you view it, the trend represents either a restoration of normalcy or simply how psychology works in an information vacuum.
“There’s muscle memory there and don’t forget there are a lot of robots out there that are launching on these things,” said Michael Purves, the chief executive officer at Tallbacken Capital Advisors. Companies that have “the ability to meet and beat, they know they get paid for that. CEOs that don’t do that or are not capable of doing that get punished.”
A key question coming into the first-quarter earnings season was how investors would approach company valuation given a lack of visibility caused by the coronavirus. Companies pulled guidance and analyst estimates grew stale by the day. Those that got updated resulted in a huge dispersion of views. By one measure, volatility on earnings announcement days was expected to be double the norm.
It’s a curious reaction to estimates that have rarely been so all over the map, with a measure of dispersion near record highs. But if history serves as a guide, the stock moves make some sense. According to Bank of America strategists including Savita Subramanian, the last time estimates were so scattered -- in early 2009 -- the reward for beats was three times the average.
A few more views on what the outsized reactions might mean:
Jason Thomas, chief economist at AssetMark: “That first order reaction is there, also the second order reaction is there -- if we think someone else is going to react to the earnings, then that will also encourage us to react. What it seems like now is there is a less center of gravity so you would expect the very short-term news to have more of an impact and that’s what we’re seeing”
Jeremy Bryan, portfolio manager at Gradient Investments: “In general are more aggressive than they have been in the past. It’s more along the lines if historically you looked at a company’s results and their guidance for the next quarter and calibrated yourself around that and people who surprise you aggressively either way -- negatively they get hit, if they surprise positively they go up. I think right now it’s the calibration of what companies, not current numbers as much, but what their forward estimates need to do.”
Take BlackRock Inc., for example, which reported on Thursday. Adjusted earnings-per-share dropped roughly 0.2% from a year prior, but that was less than expectations for a drop of more than 3%. Shares rose 3.6%, the most on any reporting day since 2012. Profits at JPMorgan Chase & Co. fell 69%, more than the expected 53%. Its stock fell 2.7%, the most on an earnings day in six years.
Industrial firm Fastenal Co. reported earnings of 35 cents a share, less than a penny more than what analysts expected. Shares surged 7%. As of Friday morning, the company was close to erasing its 2020 loss, which at one point reached 24%.
“There’s a little bit of an environment of a rush to judgment,” said Mike Swell, co-head of global portfolio management at Goldman Sachs Asset Management. “It tells you this is a very bullish sign that people are clinging to good news because there’s a lot of desire to participate in recovery.”
After the strongest 15-day run for the S&P 500 in eight decades, bears have been quick to question the stock market’s resilience in the wake of dire economic reports and earnings releases. The benchmark was up 1.5% as of 12:15 p.m. in New York, extending its gain since the trough past 27% to the highest in over a month.
There is also historical precedent for a rising stock market in a time of falling corporate profits. During market plunges going back to 1950, there was only one instance when profits rebounded before stock prices, according to Jim Paulsen, chief investment strategist at the Leuthold Group. In the most recent comparable scenario -- the financial crisis -- after the S&P 500 bottomed in March 2009, the benchmark gained 67% by the end of the year while earnings came in 30% lower.
“As post-war history illustrates, simply because earnings are headed lower does not necessarily imply the stock market has to fall further,” Paulsen wrote in a research report. “Perhaps, as it has frequently done since WWII, the stock market is already looking beyond current or even intermediate profit results and is reflecting the character of company fundamentals farther into the future.”
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