Don’t Fret Price Reversals Following Good Earnings Reports – They Are Signs Of A Healthy, Appropriately Valued Stock Market

Apple’s
AAPL
up-down, 24-hour price move is a perfect example of what’s happening in this earnings period. The reason those moves are desirable is that they are evidence of the link between pricing and fundamentals.

The earnings reports released just after the stock market’s close are especially noteworthy. The media can report the results before the next day’s market opening. Then when the trading begins in earnest, the action fully reflects Wall Street’s view.

Here is Apple’s price action, shown over the past five days, using half-hour intervals:

Analysts remain important to the valuation process

Barron’s addressed this see-saw action clearly in, “Apple Earnings Were Spectacular. Why Its Stock Dropped.”

“Apple reported an insanely great March quarter, with revenues and profits far higher than expected. It exceeded expectations in every product line and in every geography. And to top things off, Apple raised its dividend by 7%, while increasing its stock repurchase plan by $90 billion.

“At least a dozen analysts raised their targets for the stock price (ticker: AAPL) on Thursday, and every single one of them raised their earnings estimates in response to the results. Goldman Sachs
GS
analyst Rod Hall, long one of the most prominent Apple bears, threw in the towel, raising his rating to Neutral from Sell. His previous view that iPhone sales would disappoint during the pandemic was ‘clearly wrong,’ he wrote.”

As to why the stock sold off…

“Bernstein analyst Toni Sacconaghi called the quarter was ‘an absolute blowout,’ but said the numbers may have been too good, creating difficult comparisons in every business category for fiscal 2022.”

Are a company’s “too good” results an appropriate reason for selling its stock?

Yes, if analysts believe there were one-time, temporary drivers at work. However, the worry that excellent results create “difficult comparisons” for the future presumes that the higher growth rate cannot be maintained.

That concern of slowing growth is a risk addressed by all growth stock analysts, particularly when growth results exceed expectations. However, it is not a risk that investors should spend a lot of time worrying about.

Analyst modeling of future growth often includes a slowing growth rate. That’s based on the idea that, as a company grows in size, it is harder for it to produce the same percentage growth rate. While that’s a reasonable notion, it excludes the unknown developments that can happen at a growth company. For example, the things that caused Apple’s results to exceed analyst expectations “in every product line and in every geography.”

In other words, the “problem” isn’t that Apple grew too fast last quarter. It’s that analyst expectations were too low – in all product lines and all geographies. That’s why the dozen analysts immediately boosted their earnings forecasts. Next the analysts will conduct meetings with the company to understand why. Only then will they be able to determine whether the results were “too good” or an important step ahead for Apple that raises analyst expectations.

The bottom line: For most companies, valuations are appropriate in this rising stock market

The earnings report season is well along, and the price adjustments following earnings reports appear appropriate and balanced. Therefore, we can take this as a sign that the stock market is not overvalued.

Aren’t some individual stocks overpriced? Yes, but they are usually highly popular companies (e.g., Tesla
TSLA
) with an exciting story that serves as the fundamental underpinning. In the rest of the stock market, Wall Street analysts and investment managers tend to keep valuations in check by hunting for undervaluation and avoiding overvaluation.