Why do stocks sometimes go down in price after good earnings are reported? Shouldn’t they go up?
You must remember that stocks trade based on what people’s opinions of what they will be worth in the future. If a company is doing well, people will start to expect earnings to increase handsomely.
Often analysts will predict earnings for a stock to increase when they start to do well. When this happens, this will cause the stock price to go up immediately since people are now expecting earnings to go up, which could mean a larger dividend in the future. Remember that the market is very efficient at pricing into the market all current and expected news. The stock price therefore starts to go immediately, long before the news comes out. Hence the axiom, “Buy on the rumor, sell on the news.”
Often there will be what are called “whisper numbers.” These are the earnings, often beyond what the analysts are predicting, that people start whispering that the company might make. If these people start buying the stock based on an expectation that the company will beat the analysts’ earnings estimates, the price will go above what would be reasonable if the company only posts earnings in line with expectation. For this reason a stock that meets expectations, while increasing earnings above those seen last year, may actually drop sharply in price when the news comes out. People were expecting to be surprised but were not.
Another reason is that the future prospects for the company may be darkening. For example, at the peak of the oil stocks in 2008 oil companies were posting record profits. The future looked less bright, however, with the price of oil starting to decline. Because earnings were expected to fall int he future the price of the stocks dropped even though they were posting record earnings.
To ask a question, email firstname.lastname@example.org or leave the question in a comment.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.