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Why Did Apple (AAPL) Drop on an Earnings Beat?

Why Did Apple (AAPL) Drop on an Earnings Beat?

Yesterday, Apple (AAPL) released their calendar Q3 earnings after the market closed. Surpassing expectations on both the top and bottom lines, with iPhone sales meeting projections and high-margin services reporting higher-than-expected revenue, one would think this would be all good news. However, the stock responded by dropping around 4.5% in the aftermarket. It has since rebounded slightly but will still open this morning a few dollars below yesterday’s closing price. Why did the market interpret good news as bad?

When people find out that I write about the markets, one of the most common questions I’m asked is, “Why do stocks that beat earnings estimates drop so often?” It may seem nonsensical on the surface, as a company’s earnings are a fundamental factor in its valuation, and market pricing incorporates expectations. So why would a company’s stock trade lower after beating those expectations?

Sometimes, traders focus on factors other than earnings, particularly revenue. If a company beats expectations on the bottom line but experiences a decline in sales, the belief is often that the beat resulted from cost cutting, price increases, or a nonrecurring boost to profits, making it unsustainable. However, Apple also slightly surpassed revenue estimates, so this is not the issue in this case.

However, the most common reason for a counterintuitive post-earnings move is a company’s forward guidance. Although companies are not obligated to provide forecasts for the upcoming quarter or full year in their earnings statements, most do. When their forecast falls short of Wall Street analysts’ predictions, the stock will drop, regardless of the recent quarterly performance.

This seems to be the primary reason for AAPL’s decline this morning. Analysts expected Apple to provide a forecast for growth in the next quarter, but it didn’t materialize.

Apple’s fourth-quarter sales are significant, as the company designs, manufactures, and sells consumer goods, particularly in-demand products like the latest iPhone, Apple Watch, iPad, and MacBook. These holiday sales account for a substantial portion of Apple’s annual revenue. Unfortunately, AAPL is expecting Q4 revenue that will essentially match last year’s, which is disappointing for investors.

Another factor often overlooked in the market’s reaction to earnings is the positioning and sentiment of the market leading up to the announcement. As interest rate hikes appear to be ending, Apple, like most tech stocks, experienced volatility this week. Many traders were already long on the stock before the earnings release, expecting to take profits on a positive reaction. However, they were squeezed out due to the post-earnings drop, adding to the selling pressure in the thin market immediately following the release.

AAPL chart

Despite the clear reason for the drop in Apple’s stock, its logic is questionable. The bounce back from the lows this morning likely represents what is to come rather than the initial drop itself. In a period of rate hikes and when there was widespread consensus among economists and analysts that a recession was imminent until just a week ago, a forecast of flat fourth-quarter sales is not bad at all. Additionally, the growth in the services sector is crucial for Apple. This high-margin, repeatable, and sticky revenue is more important than anything else. The more Apple’s total sales rely on services, the better the company’s prospects.

All of the aforementioned factors—revenue rather than EPS, revenue composition, forward guidance, and market positioning—contribute to the stock’s reaction to earnings. While they all play a part, it is important to highlight that such moves often present opportunities for long-term investors to benefit from short-term market dynamics. This is the case with Apple. Although the company may have disappointed in some aspects, the growth in services revenue and the ability to maintain sales levels in a challenging fourth quarter are good reasons to believe that the company can continue to thrive, resulting in a significantly higher AAPL stock price next year.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.