Even Champion High Jumpers Fail to Clear the Bar

As a disappointed fan of US Soccer, I must have sports on my brain this morning.  (My wife would add “even more than usual,” but I digress.) The sport I have in mind this morning is neither football/soccer nor my usual summer baseball, but track and field instead.  The best analogy that I can conjure for the upcoming earnings season is high jumping or pole vaulting.  The bar might be set too high for some stocks to clear.

Remember, in those sports the medal is awarded only after the bar is set so high that most can’t jump over it.  Sometimes even the winners fail to clear their final attempts, such as when an athlete has a medal sewn up but fails at an attempt for a new record.  In the case of earnings reports, the company sets the bar with guidance for earnings and/or revenues, but then investors have the ability – if not the tendency, in the case of high-flying favorites – to ratchet it even higher.  If investor expectations outpace a company’s ability to meet their “whisper numbers,” even solid sets of beats and raises can lead to disappointment.

I laid out this theory in media appearances yesterday (note the 5:08 mark of this video) and related it back to the lackluster performances of Nvidia (NVDA) and Micron Technology (MU) after their otherwise excellent reports.  I didn’t expect to see it come to fruition so quickly with Samsung Electronics (5930, KRX) last night. 

Samsung fell over 9% in local trading after it said in a regulatory filing that April–June operating profit was expected to reach 89.4 trillion won (~$58.4 billion), above the analysts’ consensus of 87.3 trillion won.  That, mind you, is a 19-fold (yes, 19x!) increase over last year.  That also, apparently, was not enough to mollify investors, since the stock traded down by more than 9% last night.  It dragged down other semiconductor stocks, particularly those that make memory chips like MU, Sandisk (SNDK), and Western Digital (WDC).  It also dragged down compatriot SK Hynix (0660, KRX), which plans to list ADRs this week concurrently with a roughly $28 billion offering.  The Hynix offering could certainly be weighing on investor appetites for semi stocks since the money to buy those new shares must come from somewhere.

One of the key tenets for many current investment theses is that earnings have been great and will remain so for at least the coming quarter.  I will stipulate that last quarter’s earnings were indeed excellent and that guidance for the coming quarter was also generally quite solid – particularly in the tech sector.  I will also stipulate that there is no better reason for stocks to rally than solid bottom lines.  We buy stocks because they are a claim on a company’s future earnings and cash flows (or at least we do so in theory), and demonstrable and foreseeable increases in those factors should be reflected in higher valuations.

Unfortunately, we can’t know the full extent to which exuberant investors have added additional expectations onto those that are seemingly priced into stock prices.  It’s one thing if stock prices adjust to meet improved guidance and consensus estimates, but another thing entirely if they reflect something beyond those metrics.  In the former case, a solid beat should lead to a solid post-earnings reaction; in the latter case it can nonetheless lead to disappointment. 

That should be investors’ key concern ahead of earnings season.  If good news – and then some – is already priced in, might the bar be set too high for even the best leapers to clear?