Wall Street Is Punishing Stocks When Earnings Fail to Sparkle

Chipotle said same-store sales for the fourth quarter are now likely to decline. (Spencer Platt/Getty Images)

Key Points

• Chipotle’s stock plunged nearly 20% after management forecast a decline in fourth-quarter same-store sales.
• Meta Platforms shares fell more than 10% because of disappointing earnings and higher-than-expected capital spending for artificial intelligence.
• S&P 500 companies with negative earnings surprises have fallen an average of 5.4% this quarter, compared with a 2.6% average over five years.

The market isn’t far from all-time highs and many experts would argue that stocks are priced for perfection. That is a problem because top companies like Meta Platforms and Chipotle are reporting earnings and issuing outlooks that are a little less than perfect.

Chipotle illustrates what is happening. The popular Mexican food chain’s results, released late Wednesday, weren’t bad per se: Earnings and revenue matched Wall Street’s forecasts. But the company said same-store sales for the fourth quarter are now likely to decline, a sign of slowing demand that Wall Street wasn’t expecting.

Chipotle’s stock plunged nearly 20% as a result.

Meta also got hit hard in response to mixed results. Revenue topped forecasts, a continued sign of strength in advertising sales at Facebook, Instagram, and other Meta-owned social-media platforms. But Meta’s earnings missed expectations and the company forecast a bigger increase in capital spending than expected for this year, largely because of investments in artificial intelligence.

Meta shares fell more than 10%.

They’re not the only stocks that were hit Thursday after earnings. Microsoft was down about 3%, a modest but notable decline given that results did top forecasts. Health insurer Cigna posted a double-digit percentage stock drop because of concerns about profit margins. Shares of eBay plummeted 15% on a weak outlook.

And then there is Fiserv. It lost more than 40% of its market value Wednesday because of a drastically reduced outlook.

According to data from FactSet, S&P 500 companies reporting negative earnings surprises so far in the third quarter have fallen an average of 5.4% in response. That compares with an average of 2.6% over the past five years.

The pullbacks might seem extreme. But when you consider how richly valued many stocks are, it makes sense. Chipotle was trading for 29 times the earnings expected for next year before the stock’s Thursday tumble, while Meta had a price/earnings ratio of 25 times.

Both stocks are trading at a premium to the broader market, which itself is looking stretched. The S&P 500 is trading at 22.7 forward earnings forecasts, well above its five-year average of 19.5.

In the case of tech stocks, particularly hyperscalers like Meta, investors may be growing impatient with the amount of spending on AI. They may be eager to see more proof that the investments will pay off in the near term in the form of higher earnings and fatter profit margins.

“More than enough good news is priced into stocks thanks to AI excitement and we expect a major pullback on the horizon,” said David Trainer, CEO of New Constructs, an investment-research firm in Nashville, Tenn., in an email to Barron’s.

Another factor is that many large-cap companies are now widely held in passive index funds, which are less likely to buy or sell after earnings. So when the news is bad, any selling that takes place from active fund managers magnifies the price declines, says Michael Green, chief strategist and portfolio manager with Simplify Asset Management.

“Larger stocks are perceived as more efficient. But the prices can change a lot because of waves of idiosyncratic volatility,” Green told Barron’s. “Investors are reacting more to news because of low liquidity.”

What is more, companies aren’t getting rewarded as much for good news. Sure, there are isolated examples with hot stocks like fuel-cell provider Bloom Energy, which popped nearly 20% after posting stronger-than-expected results and an upbeat outlook. Amazon also surged Friday thanks to its stellar quarter and solid guidance. But FactSet said that the average price increase following a positive earnings surprise so far this quarter is just 0.3%, compared with the five-year average of 0.9%.

Simply put, results that outpace expectations are no longer good enough to excite investors given that the S&P 500 is up about 16% this year while the Nasdaq has surged 22%.

It is even more of an issue for big tech. The exchange-traded fund is up almost 25% this year. Nvidia, which will report earnings in November, has soared more than 50%.

“Tech is corporate America’s golden child. They’re known for quality balance sheets and wide competitive moats,” said Callie Cox, chief market strategist with Ritholtz Wealth Management, in a report this week. “Their AI pursuits could threaten these labels at a time when tech companies need to be near perfect because of high valuations.”

So far this quarter, American companies are falling short of perfection.

Write to Paul R. La Monica at paul.lamonica@barrons.com