Jacob Sonenshine

During second-quarter earnings season, a company can surpass earnings estimates and even issue decent guidance, and still see its stock drop.

With over a third of S&P 500 component companies having reported their second quarters now, the average stock-price reaction the day after a report is up just a few tenths of a percentage point, according to Evercore. A company that beats both sales and earnings expectations is seeing an average gain of 1.6%.

But there have been a handful of companies beating on both top and bottom lines -- and seeing their stocks drop afterward. Meanwhile, companies that miss both estimates are seeing an average stock drop of 5.1%, worse than the trailing five-year average of a 3.2% slump. In this environment, stocks have much more downside potential than upside right now after earnings -- and the slightest blemish on a report will disproportionately weigh on a stock, even if a company beats analysts' estimates.

The overarching reason: Stocks came into earnings season at expensive valuations. They already reflect an optimistic view of future earnings, so perfect earnings reports can't move stocks up much more, while any disappointment can certainly pull them lower. The equal-weight S&P 500, a truer representation of the average stock, trades at 17.2 times aggregate expected earnings for the coming 12 months, near its highest level since late 2021, showing that a breadth of stocks are more expensive.

Carrier Global, a maker of HVAC systems, is an example. It beat analysts expectations for both top and bottom lines, and maintained its full-year guidance. Still, the stock fell 11% Tuesday after earnings.

Sales and earnings for the second quarter came in higher, which should make a company raise full-year guidance. But Carrier didn't, and the lack of movement implies third- and fourth-quarter sales and profits will be lower than what management had originally expected, making the market nervous about slowing growth.

Carrier is guiding for full-year sales of $23 billion, which now implies second half revenue of $11.67 billion, about $11 million short of what analysts had expected shortly before the earnings release. Overall, the picture doesn't look terrible. Carrier plans to continue to offset tariff costs with about $200 million of price increases this year, while total revenue grows, partly due to exploding sales to customers building out data centers.

Driven by the mild revenue shortfall, second-half earning-per-share guidance now seems to come a few cents short of what analysts had been expecting. The fact that this caused Carrier stock to drop far more than the earnings shortfall shows that shares were likely too expensive coming into earnings.

Shares entered earnings trading at 24 times expected earnings per share for the coming 12 months. That's a hair below peers Johnson Controls and Trane Technologies, but it was also Carrier stock's highest multiple all year. Right now, the market needs to see bulletproof evidence that earnings will continue to grow aggressively -- and it didn't see enough to close the case.

Something similar happened after Texas Instruments' earnings report. The chip maker beat sales and earnings estimates on July 23, but the stock dropped after the numbers came in. The company warned that tariffs in both China and the U.S. remain part of the picture. Those two countries represent the largest percentage of the company's sales, so the market is worried about demand.

The takeaway is that the market is vulnerable to disappointing news right now. With the majority of S&P 500 component companies about to report earnings, investors should be careful about buying up too much stock.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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July 30, 2025 12:19 ET (16:19 GMT)

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