In my Instagram stories this week, a follower asked me: “Why would a stock go down after a good earnings call?”
It’s an intelligent and insightful question, because it happens frequently. Most people don’t understand why a stock price drop would happen following the release of good news.
However, there are three common forces behind this phenomenon that can cause it. Let’s explore each of them in detail below.
The Purpose of An Earnings Calls
An earnings call is a technical terms for the public conference call between the management of a public company (listed on a stock market) and the people who track or invest in it.
Commonly, the people who listen in on an earnings call include:
- Institutional investors – Institutional investors can include endowment funds, commercial banks, mutual funds, hedge funds, pension funds, and insurance companies.
- Individual investors – These are private investors like you or me.
- Stock analysts – These are professional who perform financial research and make projections about particular companies or industries.
- Competitors – These are other companies who compete for market share.
- Media – These are folks who plan to report on the company in the media.
During an earnings call, company management will report on the company’s financial results during a given reporting period, typically a quarter or the fiscal year.
Why A Stock Would Drop After A Good Earnings Call
There are three common reason why a stock would drop after a good earnings call, which include:
1) The earnings report didn’t meet investors’ expectations.
Sometimes, investors have extremely high expectations of a company.
In these cases, even if the company reports good figures, you’ll see stock price drop afterward. This is because investors expected to hear even more favorable news—and the reality fell short of expectations.
2) An unknown risk to the company was reported, such as management turnover, changing market conditions, increased market competition, etc.
When this situation occurs, investors react to the news of increased risk by selling their shares. This drives the share price down.
3) Too many investors “bought the rumor and sold the news.”
Sometimes, experienced investors will buy the stock prior to the earnings call based on rumors of strong earnings and sell afterward. They sell their shares, because the gains have already been priced in (thereby limiting the future upside).
A surge of selling after the earnings call drives the stock price down, even though good news was released.
Stock Price Drops After an Earnings Call
Intriguingly, public companies are required to disclose their financial performance. However, earnings call are not required. For this reason, some publicly traded companies do not conduct earnings calls.
Given the volatility of stock prices leading up to and following earnings calls, it is understandable why some companies would prefer this approach.
What questions do you have about why a stock price would drop (or rise) after an earnings call? Ask them in the comments below.
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