S&P 500 Sees Negative Price Reaction to Positive EPS Surprises For Q4 2017

To date, 99% of the companies in the S&P 500 have reported earnings for the fourth quarter. Of these companies, 73% reported actual EPS above the mean EPS estimate, which was above the five-year average of 69%. In aggregate, earnings exceeded expectations by 4.4%, which was slightly above the five-year average of 4.3%. Due to these upside surprises, the earnings growth rate for the S&P 500 has improved to 14.8% today from 11.0% on December 31.

Given the stronger performance of companies relative to analyst EPS estimates and the improvement in the growth rate over the past few weeks, how has the market responded to upside EPS surprises during the Q4 earnings season?

Companies in the S&P 500 that reported positive earnings surprises for Q4 have seen a decrease in price of 0.2% on average from two days before the company reported actual results through two days after the company reported actual results. Over the past five years, companies in the S&P 500 that have reported positive earnings surprises have witnessed a 1.2% increase in price on average during this four-day window.

If the final percentage for the quarter is -0.2%, it will mark the second time in the past three quarters in which S&P 500 companies reporting positive EPS surprises recorded an average decline in price over this four-day window. In Q3 2017, S&P 500 companies that reported positive EPS surprises saw an average decline in price of 0.3% two days before the report through two days after the report.

Of the 366 S&P 500 companies that have reported positive earnings surprises for Q4, 207 (or 57%) recorded a decline in price over this period. The average price decline of these 207 companies over this four-day window was -4.0%. Of these 207 companies, 13 witnessed a double-digit decline in price.

An example of one of these 13 companies is Chipotle Mexican Grille. After the closing bell on February 6, Chipotle reported actual (adjusted) EPS of $1.34, compared to the mean EPS estimate of $1.32. However, from February 2 through February 8, the price of the stock fell by 14.6% (to $266.01 from $311.64).

Why Did the Market Punish Positive EPS Surprises during This Earnings Season?

In aggregate, it was not due to forward EPS guidance or analyst revisions to EPS estimates for the first quarter and full year. To date, fewer S&P 500 companies have issued negative EPS guidance for Q1 2018 (49) compared to the five-year average (80). In aggregate, analysts have increased EPS estimates by record amounts for Q1 2018 and CY 2018.

The average price decline was likely due to a combination of the high valuation of the market during the month of January and the subsequent price decline of the market in early February. During the month of January, the average forward 12-month P/E ratio for the S&P 500 was 18.3. This forward 12-month P/E ratio was above the four most recent historical averages for the S&P 500: five-year (16.0), 10-year (14.3), 15-year (14.5), and 20-year (16.0). Thus, despite the number and magnitude of positive earnings surprises in the fourth quarter, the market may have been be reluctant to push valuations even higher.

After hitting a peak value of 2872.87 on January 26, the value of the S&P 500 fell by 10.2% over the next nine trading days, closing at 2581.00 on February 8. During this period of declining value (from January 29 through February 8), 204 S&P 500 companies (or 41% of the index) reported actual results for the fourth quarter. Since February 8, the value of the index has increased by 6.1%. With this increase in value, the forward 12-month P/E ratio now stands at 17.0, which is still above the four most recent historical averages.