Anyone who thinks stock markets are efficient should look at what happens to stock prices immediately after announcing quarterly earnings. Stocks that easily beat barely move, while those missing badly seem to go up, often by large amounts. There appears to be no rhyme or reason to the trading patterns of stocks once the news is public knowledge. To demonstrate, I'll take five announcements from May 21, both good and bad, seeking to understand why these stocks move the way they do. I'm not very confident I'll find an answer.
IN PICTURES: How To Make Your First $1 Million
May 21/09 Earnings Surprises
|Company||% Surprise||Stock % Up/Down Day After|
|Patterson Companies (Nasdaq:PDCO)||-8.00%||-10.59%|
|MF Global (NYSE:MF)||-171.43%||9.39%|
These two specialty retailers have shared the spotlight during the recession. While most everyone except Wal-Mart (NYSE:WMT) has struggled to grow sales, Buckle and Aeropostale have consistently delivered strong same-store sales numbers over the last few years. In fact, Buckle has produced 31 consecutive months of positive comps and Aeropostale has done something equally impressive, growing same-store sales for 11 consecutive years. You can't get more consistent than that.
There's not much both companies don't do right. Buckle's first quarter was flawless, delivering a 44% increase in profit from 40 cents per diluted share one year ago to 58 cents. This came along with a 17.7% increase in comparable-store sales. Aeropostale increased earnings per share (EPS) 81% to 47 cents and posted an 11% increase in same-store sales. At the end of the day, Buckle beat Q1 estimates by 16% versus 2.08% for Aeropostale. Despite a positive earnings surprise differential of 14%, each stock was up between 3% and 6% the day after announcing earnings. Buckle definitely is the underdog here. (Consensus estimates can send stocks spiraling - but are they representing reality? Read Surprising Earnings Results.)
I initially assumed the 9 percent drop in its stock price after easily beating estimates was an example of the old adage, "Buy on rumor and sell on news." Not so. It seems investors didn't appreciate the company revising its full-year guidance for the second time this fiscal year. They were a little quick to judge. The company lowered revenue to between $1.25 billion and $1.27 billion while increasing earnings per share to 59-60 cents, above analyst expectations of 55 cents. So, let me get this straight. In the Q1, it increases sales and earnings by 92% and 23%, respectively, while also raising full-year EPS 4-5 cents higher than analyst estimates, yet a $60 million projected drop in sales over a 12-month period justifies close to a double-digit decline in its stock price? Not on your life.
Patterson Companies/MF Global
This is perhaps the oddest example of trading patterns. Here you have futures and options broker MF Global missing estimates by 171.43%, yet its stock rises 9.39% on the news, while dental and veterinary product supplier Patterson Companies misses by 8% and its stock drops almost 11%. Frankly, I don't know why companies bother with press releases. They make absolutely no difference to investors who've already made up their minds about a stock. It's a complete waste of ink. (Sometimes, positive anouncements can mean bad news for a stock. Find out why in Can Good News Be A Signal To Sell?)
What exactly was Patterson's egregious mistake? Its Q4 EPS missed analyst estimates by 4 cents, 46 cents to 50 cents, while sales actually rose slightly. No, the real error here was its CEO's admission that it didn't perform well in the Q4 in any of its three divisions, and the next two or three reports would be equally unimpressive. It doesn't matter that projected EPS should be higher than $1.69, which was the result in each of its last two fiscal years. Honest investor relations are never a good thing. No matter what you say, people are going to make their own interpretations.
As for MF Global, its Q4 was an outright disaster. Even excluding an $82 million non-cash goodwill impairment charge from its results, it still lost 5 cents a share on a 37% drop in revenue. What does the stock do? It jumps almost 10% after the announcement. If you can figure out why, you're smarter than I am.
Where are the efficient markets that academics write about so often? I don't see them and I never will.