BREAKINGVIEWS-Big earnings reactions dent public market’s appeal

By Aimee Donnellan

LONDON, May 21 (Reuters Breakingviews) - Even a casual stock-market observer might have noticed some extreme share-price reactions to corporate earnings announcements of late. On the same day in late April, for example, software group ServiceNow NOW.N and toymaker Hasbro HAS.O rose 15% after investors cheered their quarterly updates, while payments processor Fiserv FI.N crashed 19%. Last week on the other side of the Atlantic, meanwhile, British fashion label Burberry BRBY.L surged 17% as French train maker Alstom ALSO.PA crashed by the same amount.

The evidence suggests that violent price swings are becoming more common, and that some of the moves may briefly exceed what’s justified by the news. The possible reasons – a combination of fast-money hedge funds and passive investing – may sound arcane, but the consequences could be stark: public companies may be more willing to go private, while unlisted ones could be less likely to float in the first place.

Results seasons, when CEOs present their most recent quarterly reports and sometimes update their targets for the year, are getting more dramatic. Bank of America said in February that European companies that missed fourth-quarter earnings expectations posted a share-price drop that was 2.6 percentage points worse than the wider market, which was the sharpest average relative swing since its analysts started crunching the numbers 13 years ago. The flipside – positive moves in response to better-than-forecast results – was 1.7 percentage points, the second-highest reading since 2012. The story is similar in the United States, according to the same bank’s Wall Street watchers, who calculated that companies that missed analysts’ revenue and earnings forecasts initially underperformed the S&P 500 by 3.6 percentage points, compared with a historic average of 2.5 percentage points. The data covered the current first-quarter 2025 reporting season.

It’s possible that post-results volatility reflects a more chaotic reality. On that view of the world, also known as the efficient market hypothesis, investors are just factoring in the new information such as slower growth or new revenue forecasts issued by CEOs and finance chiefs. Perhaps that new information is just more dramatic than it was in the past, because of trade wars and other geopolitical tensions, explaining the sharp swings.

There’s evidence to support this view. The VIX index of volatility, often known as Wall Street’s fear gauge, has had a higher average level in the post-pandemic years than in the run-up to 2020, suggesting that investors overall are positioned for bigger short-term moves in the S&P 500 Index. Morgan Stanley reckons that the ratio of earnings upgrades to downgrades, among stock analysts, recently reached its lowest level in Europe since the pandemic, implying unusually disappointing results and corporate financial targets. In the United States, this so-called earnings revision ratio has been close to record lows, reckon Bank of America market-watchers. In other words, sharper stock moves may be justified.

Yet that theory is hard to square with some of the most extreme examples. The roughly one-fifth selloff in $94 billion Fiserv’s stock on April 24, for example, followed a growth slowdown in one of its payments processing divisions. Yet incoming CEO Mike Lyons stood by the group’s full-year revenue forecast, and analysts at TD Cowen said the results were “not a thesis-changing” update. The shares subsequently beat the S&P 500 over the next five trading days by 1.3 percentage points while ServiceNow and Hasbro, which soared on April 24, subsequently lagged the key U.S. stock benchmark over the same period. In other words, in some cases there’s circumstantial evidence of an earnings-day overreaction.

An alternative explanation for results-day volatility may lie in the nature of the investors doing the buying and selling. Last year, a Reuters News analysis confirmed the trend of much sharper earnings-driven share price moves in Europe. Citing interviews with two dozen traders and investors, the report pinpointed the rise of so-called “fast money” investors including highly leveraged multi-strategy hedge funds. These players, like $73 billion Millennium Management and $66 billion Citadel, can use lashings of debt to boost the size and returns of their stock wagers, which often involves betting on whether earnings announcements will meet market expectations.

Their influence is arguably compounded by the relative lack of long-term “buy and hold” investors willing to scoop up shares on the cheap, smoothing out market moves. That’s because the rise of passive index funds, run by BlackRock or Vanguard, has put the squeeze on old-fashioned stock pickers, shrinking the number of market players that actively trade. The upshot is that the incremental buyer or seller is more likely to be a levered short-term investor, or perhaps a computer algorithm, helping to explain violent price moves. One executive of a company that recently suffered a sharp selloff told Breakingviews that the firm’s financial advisers pinpointed superfast quantitative funds as the key selling force.

Regardless of the causes, the question is what management teams can do about it. Wild gyrations can lead CEOs to spend more time explaining away stock moves than running the company, bosses complain behind closed doors. And financial theory states that volatility should cause investors to use a higher cost of equity when assessing a company’s worth, depressing valuations and making share sales more expensive for companies.

One way to avoid the risk of disappointing investors is to be much vaguer in the first place. That would imply fewer specific numbers in executives’ revenue and earnings growth forecasts, and more fuzzy ranges instead. Apple AAPL.O Chief Financial Officer Kevan Parekh, for example, said earlier in May that he expected the company’s top line in the next quarter to rise by “low to mid-single digits” in year-on-year terms, which could mean anything from around 1% to 5% or even more. Such unhelpfully wide ranges may become more common.

Another consequence is that smaller and mid-sized company CEOs may look more kindly on any buyout offers from private equity funds. Blackstone BX.N, KKR KKR.N and their ilk often tout their ability to turn companies around away from the unforgiving glare of public markets and quarterly updates. That promise arguably seems even more appealing in the context of earnings-day volatility. Meanwhile, unlisted giants like payments group Stripe and Elon Musk’s rocket company SpaceX, recently valued at $92 billion and $350 billion respectively in share sales, arguably have yet another reason to put off a float. Their ability to raise money and cash out employees while staying private has already reduced the appeal of an initial public offering. The prospect of exaggerated earnings-day swings hardly helps the case for a listing.

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