4 Reasons Why a Stock May Pull Back After Earnings Dear Leah, The second-quarter earnings announcement season is relatively wrapped up. And it was the strongest earnings season we've had in a while. FactSet reports that the S&P 500 achieved about 11% average earnings growth in the quarter, which was the highest growth rate since the fourth quarter of 2021 (31.4%). Also notable, 79% of S&P 500 companies topped earnings estimates, by an average of 3.5%. Now, you may have noticed something strange happen during this earnings season. It occurs just about every quarter, but it was just a little more pronounced than usual this time. A stock might miss analyst estimates, but as long as management provided positive guidance, it was rewarded. On the other hand, we've seen some stocks smash estimates only to get shot by investors. This is one of the great mysteries of investing. In fact, it prompted a great question from a reader: "I find it odd that when positive earnings are announced, a stock's price goes down at least temporarily. Why does this occur?" If you've been around the market long enough, you've probably experienced the same thing. And it can be incredibly frustrating and confusing. Some stocks may pull back in the wake of posting positive earnings beats. Others, meanwhile, soar higher after posting a positive earnings surprise. For example, Eli Lilly & Company (LLY) jumped 9%, Meta Platforms, Inc. (META) soared by nearly 10% and Target Corporation (TGT) soared by 10%. So, in today's Market 360, I'll share four reasons why a stock can suffer an initial drop even though it reported solid earnings numbers. I'll also explain why it's important to continue investing in fundamentally superior stocks, even though earnings season is now mostly behind us. Reason No. 1: Misses Expectations Let's consider Microsoft Corporation (MSFT). On the surface, it seemed that it achieved solid results in its fourth quarter of fiscal year 2024. On July 30, the software giant reported revenue grew 15% year-over-year to $64.7 billion, topping estimates for $64.39 billion. Fourth-quarter earnings rose 10% year-over-year to $22.0 billion, or $2.95 per share. Analysts expected earnings of $2.93 per share. For its fiscal year 2024, Microsoft reported total revenue of $245.1 billion and earnings of $88.1 billion, or $11.80 per share. That represented 16% annual revenue growth and 22% annual earnings growth. The consensus estimate called for full-year revenue of $244.94 billion and earnings of $11.80 per share. Sounds just about perfect, right? The company's Intelligent Cloud revenue, however, disappointed investors. The segment, which is Microsoft's top division, generated $28.5 billion in revenue, which was up by about 19% year-over-year but below the $28.7 billion estimate. As a result, the stock dipped about 3% before recovering.
Reason Reason No. 2: Weak Guidance On Wednesday, August 21, Macy's, Inc. (M) released its latest quarterly results. The department store chain reported adjusted earnings of $0.53 per share, handily beating expectations of $0.30 per share. Now, the company's revenue did come up short. It reported $4.94 billion in sales, compared to an expected $5.12 billion. But what really disappointed investors was the company's outlook. Macy's said it expects full-year net sales of $22.1 billion to $22.4 billion, which is lower than the $22.3 billion to $22.9 billion range it had previously forecasted. That would also be down from the $23.09 billion it reported in 2023. That was enough to discourage investors hoping for signs of a turnaround at the iconic retailer, and shares sank about 13% on the news. Reason No. 3: Analysts Misread Results
On Monday, August 26, cybersecurity firm Alarum Technologies Ltd. (ALAR) pulled back sharply after reporting a second-quarter earnings loss of $0.05 per ADS, compared to an earnings loss of $2.26 per ADS in the second quarter of 2023. Estimates called for earnings of $0.31 per ADS. And while that was a significant earnings miss, it's worth noting that Alarum achieved operating earnings of $0.41 per share in the second quarter. Now, operating earnings provide a clearer picture of a company's financial health without the impact of one-time events or non-operating activities, and analysts and seasoned investors should know this. But the damage was done, and the stock fell sharply. Reason No. 4: Priced for Perfection On Wednesday, NVIDIA Corporation (NVDA) released second-quarter results that exceeded both top and bottom-line forecasts. What's more, it said that it expects third-quarter revenue of about $32.5 billion, or 79.4% year-over-year revenue growth. The outlook is slightly higher than analysts' current projections of $31.77 billion. Still, NVIDIA shares dipped on Thursday, as it was clear that investors wanted blowout quarterly results. This is a perfect example of what happens when investors are conditioned to demand perfection. NVIDIA's earnings were fantastic, but investors had even loftier expectations. (Read my full earnings review for NVIDIA here.)
The Takeaway
It's also important to note that stocks tend to pull back after a post-earnings surge. In my experience, it's not unusual for a stock to give back at least a third of its gains. So, if a stock surges 12%, then we can expect a 4% pullback. So, while it's disappointing when a stock doesn't bounce higher in the wake of a quarterly earnings beat, it's not a sign that something is wrong behind the scenes. As long as the companies continue to have solid earnings momentum, positive analyst revisions and persistent institutional buying pressure, then I view any dip as a great buying opportunity. The simple reality is good stocks bounce like fresh tennis balls, while bad stocks bounce like rocks. This is why it's important to remember what Warren Buffett famously said about the market when paraphrasing his mentor, Ben Graham: "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." What this means is that the market isn't a single entity – it's comprised of the opinions of millions of other investors. So, the collective psychology of those individuals may prevail, but only in the short term. This is why I only recommend fundamentally superior stocks in Growth Investor… a strategy that has paid off handsomely this year. My Growth Investor stocks have beaten the S&P 500 by almost 2 to 1 in August. My High-Growth Investments Buy List has rallied about 25% higher in the past eight months, versus the S&P 500's 17% gain and the Dow's nearly 10% rise. Collectively, my Growth Investor stocks sport average annual sales growth of 28%, 498.7% average annual earnings growth, 28.3% average earnings surprises and 57% average annual dividend growth. Overall, I am excited about the future for our fundamentally superior stocks. And I hope you'll join us for the ride. Click here to find out how to become a Growth Investor member today. (Already a Growth Investor subscriber? Go here to log in to the members-only website.) Sincerely, | .png)
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