If you've invested long enough, you've seen at least one of your stocks move its price dramatically over the course of a single day. It can be shocking when it happens, but it actually happens quite often with all kinds of stocks, particularly around earnings season.
Share prices of industrial giant Emerson Electric (EMR 0.27%), for example, dropped a touch over 7% after the company reported fiscal 2023 fourth-quarter earnings. The reason and the implications for long-term investors, however, may not always match up. When you see a big drop, you need to dig in and understand what's really going on.
Emerson's results were a big improvement
At first glance, there was a lot to like in Emerson's Q4 update. For example, sales increased 5% year over year in the quarter. They were up 10% in fiscal 2023 over 2022. Adjusted segment operating earnings before interest, taxes, depreciation, and amortization (EBITDA) margin rose 80 basis points in the quarter and 220 basis points for the year. Adjusted earnings increased 21% year over year in Q4 and 22% over the fiscal year. And Emerson generated 17% more free cash flow in the quarter, with the full-year increase at 35%.
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Emerson also provided guidance for fiscal 2024 with its earnings release. Underlying sales are projected to increase 4% to 6%. Adjusted earnings are expected to total between $5.15 and $5.35 per share, notably higher than the $4.44 earned in fiscal 2023. Free cash flow for the industrial company is projected to be between $2.6 billion and $2.7 billion, up from $2.36 billion in the just-ended fiscal year.
Those forecasts seem pretty good and are trending in the right direction -- higher. And yet, the stock price fell on the news. You have probably figured out the reason already: Wall Street was expecting more.
How big of a problem is an earnings miss?
Sometimes, companies miss earnings dramatically and offer up big negative surprises when they provide their quarterly business updates. In those situations, investors often sell hard and fast, leading to material price declines. But that's fairly easy to understand. Other times, however, the miss isn't particularly large, with a big stock price drop being the more shocking event. That's pretty much what happened with Emerson.
The company missed Wall Street's top-line estimate by a little under three percentage points. And the bottom-line miss on the earnings statement was just a single penny. To be fair, with a company like Emerson, which has a market cap of $48 billion, that 3% sales miss is over $100 million. And a penny a share in earnings isn't exactly chump change, either, when you multiply it by the 577 million shares the company has outstanding.
Still, these are fairly modest shortfalls, given the general direction of sales and earnings was higher. And more of the same (higher) is expected in fiscal 2024. If you are a long-term investor looking at the big daily stock price decline, you need to dig and understand why. And then ask yourself whether it's more important that the company continue to improve or that it missed earnings expectations by a mere penny a share. If you consider the dramatic price move in that light, you'll probably view the drop as an overreaction.
Wall Street can get emotional at times
It would be nice if investors reacted to news in a purely clinical manner, but that's just not the case when you take Wall Street as a whole. Indeed, emotions tend to win out more often than not. But you don't have to succumb to Mr. Market's whims if you step back and consider the long-term implications of a short-term event (like a single quarter of earnings).
In other words, while you can't control big stock price moves, you do have total control over what you do about them. It's probably best to take the time to think and act rationally instead of emotionally, noting that Emerson is just a single recent example of a frequently repeating pattern.
