Indicator of the Week: Time to Be Cautious on Large-Cap Stocks?

Apple Inc. (NASDAQ:AAPL) and Amazon.com, Inc. (NASDAQ:AMZN) went in different directions after earnings, but their longer-term fates may be identical

Senior Quantitative Analyst
May 4, 2016 at 7:15 AM
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It has been an eventful earnings season so far, with some large-cap stocks making very big moves. Apple Inc. (NASDAQ:AAPL) fell more than 6% after its earnings report, which was a loss in market cap of over $42 billion. To put that in perspective, the loss was bigger than the entire market cap of Netflix, Inc. (NASDAQ:NFLX), valued at roughly $40 billion, or Monsanto Company (NYSE:MON), valued at $41.8 billion. Elsewhere, Microsoft Corporation (NASDAQ:MSFT) dropped over 7% after earnings, or shed about $34 billion of market cap.

On the other side, Amazon.com, Inc. (NASDAQ:AMZN) was up 9.6% on earnings, or added $27 billion in market cap. Facebook Inc (NASDAQ:FB) also added the equivalent of a large-cap stock to its market cap. This week I'll take a look at how stocks react to these huge moves in company value.

Big AAPL Losses: First, since it's such a popular stock, we'll look at AAPL. Below are the seven times the stock lost at least 5%, amounting to over $25 billion in market cap. What can we expect going forward? Well, pretty much anything, unfortunately. The three-month returns following such a swing have run the gamut from an almost 20% gain to a 20% loss, and anywhere in between. One thing to note is that unless there's a big gain today (today is the fifth trading day since the recent AAPL decline), it will be worst five-day performance after the big AAPL declines.

AAPL after big losses May 3

Stocks Returns After Large Market Cap Moves: I wondered if huge companies tended to behave a certain way after large daily moves in market cap. Going back to before the tech bust, I found all occurrences when a stock gained or lost at least 5%, amounting to more than $25 billion in market cap. I only have data on stocks currently trading, so stocks that no longer exist due to bankruptcy, mergers, etc., are not counted. The first table summarizes the returns after large gains, and the second table summarizes returns after large losses.

Big Market Cap Changes May 3

The day after a large gain or loss tends to be a mean-reverting day, or maybe a profit-taking day. In other words, the following day has tended to move in the opposite direction as the prior day's big move. Stocks making big one-day gains were positive the next day only 40% of the time, averaging a slight loss. Stocks that suffered a huge one-day loss were positive almost 60% of the time the next day, gaining on average 1.74%.

Interestingly, as you go farther out on your time frame, the stocks -- whether making big gains or big losses -- have tended to underperform. Looking at the three-month returns after stocks made huge one-day gains, the average return was a loss of 7.88%. Barely 40% were positive and 47% outperformed the S&P 500 Index (SPX). Three months after a huge single-day loss, the stocks averaged a loss of over 6%, with about 45% of them positive and just 43% beating the SPX. The huge moves in market cap, whether up or down, may generally signal instability and uncertainty in the stock price and precede a sell-off.

A large majority of the stock moves above were during the tech bust or during the volatile period of 2008-2009. Therefore, I collected the same data, but only for stocks making big moves since 2010. The number of returns (15 up and 15 down) may not be all that significant, leading to some pretty lumpy returns -- but, again, these stocks show some underperformance.

Looking at 15 stocks that made huge gains, they average a one-month loss of nearly 2%, with only one-third of them positive and one-third outperforming the S&P 500. The three-month returns, though, are pretty strong, since a couple stocks made some big comebacks after that first month of trading. Since 2010, the stocks suffering big losses in a day also tended to underperform going forward. It surely catches your eye when a large-cap stock makes an outsized move, but this analysis suggests caution in these instances if you're thinking of buying.

Big Market Cap Chances since 2010

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