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Investors to Companies: We Don't Care About Your (Bad) Earnings

Monday, 1 Jul 2013 | 1:29 PM ET
Don Bayley | E+ | Getty Images

A record number of S&P 500 companies have issued negative earnings guidance for the second quarter. But a funny thing happened on the way to the quarterly reports: Investors stopped caring about all the bad news.

For the second quarter, 87 S&P companies have issued negative guidance, making 81 percent of preannouncements negative. If this holds, both the percentage and the sheer number of companies will set records, beating out the 86 companies who issued negative guidance for the first quarter of the year (which made for 77 percent negative guidance). This according to research company FactSet.

But FactSet senior earnings analyst John Butters points out a surprising trend. "Although the number of negative preannouncements is running at an all-time high, the market is not punishing the performance of these stocks in the short-term," Butters wrote in a Friday note.

This is a recent development. Over the past five years, companies that have issued negative earnings guidance has seen their share price drop by an average of 1.2 percent — as Butters measured by comparing the share price two days before the preannouncement to the price two days after. But when he looked at the shares of the 87 companies that issued negative guidance for the second quarter, he noticed that the shares gained an average of 0.1 percent around the bad news. In fact, "More than half of the companies (46) that have issued negative guidance recorded an increase in price during this time frame," Butters reported.

And while one might theorize that the market is simply tuning out earnings, it appears that investors are paying even closer attention to good news. Companies that issued positive earnings guidance saw their shares rise by 3.2 percent around the news, besting the average 2.9 percent increase over the last five years. For some reason, it seems that only the bad news is getting swept under the rug.

"I'm not sure what to chalk that up to," Butters said. "Many of these preannouncements came in April and May, so many the overall trend of the market was helping to offset that." But that brings up a related peculiarity: The market rose precipitously at the same time that a record number of companies were giving negative guidance.

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So if earnings fall in a forest, but investors pretend they don't hear it, does it make a sound?

"I think it's probably a matter of sentiment," said Brian Stutland of the Stutland Volatility Group. Given the interest rate environment, "If there's any kind of growth, it's worth it to be invested in stocks rather than a 10-year Treasury note over the next 10 years."

To Stutland, investors are desperately listening out for good news — and more or less ignoring the bad. "Even if a company lowers their outlook to negative, as long as it's still net positive, you'll still want to own the stock," he said. "And if there is any prospect of good news that there is going to be growth, that gives you a reason to buy the company."

Rhino Trading Partners Chief Strategist Michael Block similarly pointed to the importance of non-company-specific factors. "A stock could be trading off macro reasons that have nothing to do with earnings," he said. "When the dust settles, stocks can go higher no matter what."

But Block also suggested that a more insidious development that could be in the works. "This might be proof that the sell side is horribly behind the buy side," Block said. In other words, the major buyers of stocks could know what's going on with companies before the professional analysts do — meaning negative preannouncements surprise the analysts alone.

"Things get baked in far before they're announced, because of buy-side expectations. They're more on top of these things, and as we've learned, it's the buy side that ultimately matters," Block said, adding, "Maybe that's not what people want to hear, but that's my assessment."


— By CNBC's Alex Rosenberg. Follow him on Twitter: @C NBCAlex.

Follow the show on Twitter: @CNBCOptions.

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