By Hardika Singh
Wall Street is showing little patience for companies that don’t live up to expectations.
With the first-quarter earnings season nearly over, companies in the S&P 500 are on pace to deliver a 5.4% jump in profits from a year ago, the biggest increase in nearly two years, according to FactSet.
But those that fall short of investor forecasts are being punished more heavily than usual. Shares of companies that missed estimates have slid an average of 2.8%, compared with the five-year average of a 2.3% decline.
Meanwhile, companies that outperform aren’t being given any special prizes. Those that beat analyst forecasts have seen their shares gain an average 0.9%, roughly in line with the five-year average of a 1% advance. That is according to FactSet data that looked at share prices in the two days before companies reported through the two days after.
“[The market] won’t ask questions; it will just reduce valuations really quickly if you don’t perform,” said George Goncalves, head of U.S. macro strategy at MUFG Securities Americas.
Companies are being given little room for error in part because stocks are looking pricey, especially in light of the lingering uncertainty about whether the Federal Reserve will cut interest rates this year. Starbucks was among those that suffered repercussions for disappointing investors late last month.
The coffee chain pledged to speed up service and roll out new drinks after a sharp slowdown in visits hit its sales and profit. Shares nevertheless sank 16% the day after it reported results and are still down almost 14%.
Discount retailer Five Below’s profit also fell short of Wall Street forecasts, despite another quarter of strong sales growth, as it invested in curbing theft through measures like beefed up security. Its shares tumbled over 15% the day after it reported results in late March, and the decline has deepened to more than 30% since the results.
In other cases, companies are being punished even when beating expectations. Netflix last month posted sales and profit that came in above forecasts, boosted by a surge in new customers. But the streaming giant gave a softer-than-expected revenue outlook for the current quarter, and its shares fell 9.1% the next day. The stock has since recouped most of its losses.
The high bar for companies this earnings season reflects investors’ nerves over stocks that are richly valued. The S&P 500 is trading at about 20 times expected earnings over the next 12 months, above its 10-year average of 18. The prospect of persistently high interest rates, meanwhile, has lessened the appeal of stocks relative to bonds, while raising the possibility of higher borrowing costs for companies.
The S&P 500 remains 0.6% off its record high in March. The benchmark index advanced 1.9% this past week, boosted by more recent signs of an economic cooldown, and is up 9.5% for the year.
The 10-year Treasury yield, a key driver of mortgage rates and other borrowing costs, was at 4.5% Friday. That was up from 4.18% seen at the beginning of March but off its 2024 high of 4.71% in late April.
“The market has to reset expectations,” said Tim Hayes, chief global investment strategist at NDR. “There’s maybe a little more realistic view of where things are going, realistic on what the earnings can be.”
Hayes said the shift on rate-cut expectations will step up pressure on all sectors to deliver spotless results, not just the Magnificent Seven group of tech stocks that have powered the S&P 500’s earnings growth over the past year.
For now, tech stocks remain in the driver’s seat. With six of the Magnificent Seven companies having reported first-quarter results, earnings for the group are expected to surge 48%, compared with a decline of 2.2% for the other companies in the S&P 500, according to John Butters, senior earnings analyst at FactSet.
The S&P 500’s communication-services sector, home to Amazon.com and Tesla, is beating Wall Street expectations by the second-biggest margin, boosted by shares of Alphabet and Netflix. But the information-technology sector, which holds Apple, Microsoft and Nvidia, is beating earnings projections by the third-lowest margin out of the index’s 11 sectors.
Don Nesbitt, a senior portfolio manager at F/m Investments, said that is worrisome because tech stocks account for about a third of the index’s returns.
“That’s where we see a lot of risk right now,” Nesbitt said.
Write to Hardika Singh at hardika.singh@wsj.com