Most people’ first question, when they find out that I am a contributor at Nasdaq.com, is “Where is the stock market going?” My response is usually unhelpful and cynical, but brutally honest: “Up and down.” If they are not the sensitive types who might take offense at the flippancy of that reply and we continue to talk about the market, their next question is often about why stocks so often behave “illogically” after earnings, either dropping after a beat or rising after a miss.
That demands a more nuanced and complex answer than a cocktail party setting allows, so I usually give a generalized answer about factors other than earnings. However, those who want to understand that phenomenon could look at yesterday's earnings, where we got such an example that showcases one of the most common reasons for a confusing reaction to earnings.
General Electric (GE) beat on the bottom line but saw their stock drop by a significant amount shortly after the release. When looking at a counterintuitive move in a stock after earnings, one of the most common reasons is disappointing forward guidance, and that is what happened here. Yes, GE reported a beat of expectations on both the top and bottom lines in Q4, but they also said that their projected earnings per share for the first three quarters of this year were $0.60-$0.65, well below the consensus estimate of $0.72.
Obviously, that is important and influential. While actual realized profits factor into a stock’s price, the market is always looking forward. Trading and investing are inherently speculative, making what will, or might, happen much more important than what has happened over the last three months. In GE’s case, disappointing forward guidance is nothing new, as can be seen by the fact that over the last four quarters, they have beaten expectations consistently and comprehensively, by an average of over 50% in fact.
Analysts’ expectations are based on their own models, but when a company gives forward guidance, that guidance is the starting point for these different projections. Those consistent beats in terms of EPS therefore indicate conservative guidance and, given that the planned breakup of the once sprawling company is upon us, an even more conservative approach than usual would be no surprise at all.
There is also another factor at play here: the continued underestimation by Wall Street of the job done by GE CEO Larry Culp. Over the last couple of years, I have sung his praises a couple of times, here and here, but he generally remains someone whose successes go underappreciated. Maybe it is because he is not the kind of person to indulge in shameless self-promotion on social media or say sensational things for the sake of saying such things, or maybe it is because the path to his success -- big cuts in costs -- is not popular in some circles. Whatever the reason, GE’s spectacular turnaround remains a quiet success story and that leads to analysts missing low on their EPS forecasts.
It is therefore no surprise to me that this morning, as calmer minds analyze GE’s Q4 results, the stock is bouncing back and looks set to open only slightly below yesterday’s close. This is yet another quarter of better than expected profits and margin improvement at GE, something that shouldn’t be overshadowed by the company’s usual “disappointing” guidance.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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