A company reports a good quarter and its share price goes down. Another company reports terrible results and the share price goes up. What’s the reason for this behavior?
First, it is important to understand the correlation between a stock’s price and the growth of the company’s sales and earnings. Over the long-term, companies that are able to grow their revenues and profits will be rewarded by seeing their valuations increase. And a company that is unable to generate growth over time will not see the price of its shares grow.
In the short-term, however, the correlation between a company’s growth and its share price is often much weaker as investors weigh other factors about a company’s past and expected performance. Investors and analysts alike play a complex guessing game, trying to match a stock’s future price with not only their expectations of the company’s prospects, but also what they perceive to be the expectations of other investors about that same company.
John Maynard Keynes described this process as a beauty contest in which the judges do not select their personal choices as winners, but instead select the candidate they believe the other judges are most likely to select. For small company stocks, this effect can be even more pronounced, as investors have less information to sift through, and are therefore more susceptible to being swayed by what they perceive will be the actions of other investors when news is reported about a company.
In the short-term, then, the market often tends to function in less than rational ways. Still, the reasons for a counter-intuitive price change can often be identified with a quick scan of press releases and news stories at a website such as Yahoo! Finance.
When a Company Reports Good News and the Price Goes Down
When a company reports what appear to be terrific quarterly results, it seems logical to expect the stock’s price to go up. But sometimes the price goes down in these cases because management provided guidance about future results that was concerning. In other cases, results were below analysts’ estimates for the quarter, and that can be enough to raise red flags. Some companies make a habit of exceeding analyst expectations or their own guidance, and when they merely meet expectations, it is perceived as negative.
The price could also decline after good news because the news was too good, and investors are now selling in order to take profits on their positions using the old “don’t look a gift horse in the mouth” rule. It could also be that the market was expecting the positive results and the price already ran up in advance of the earnings announcement, and investors simply shrugged off the news.
Finally, in some cases the price isn’t impacted by an official earnings announcement because the company had already preannounced the news and investors have had ample time to digest the impact.
When a Company Reports Disappointing Results and the Price Goes Up
So why does the price of a stock sometimes move upwards when a company releases negative news? Perhaps management released guidance that was very positive even though recent results were less than stellar. Or it could be that the price had already declined in anticipation of poor results, so now that the extent of the damage is known, investors are taking advantage of the price decline to buy in.
Of course, bad news is seldom good for a stock’s price, so a stock would continue to fall if shareholders exit en masse following a poor showing. The exit could be exacerbated if the results are much worse than expected.
At the End of the Day
Keep in mind that many market participants watch technical or momentum indicators, and their signals are quite different from the factors held in high esteem by fundamental investors. The reason that a stock’s price moves up or drifts down or doesn’t change when an apparent catalyst occurs may never be known with certainty—at least in the near-term.
But in the long-term, capital appreciation is always driven by long-term results. Occasional drawbacks that companies experience may not be relevant to their long-term success.