You've likely heard theadage, "buy the rumor,sell the news," which is the tendency for traders to push up a stock's price on rumors or expectations and then sell once that news has been released, even if the news is positive. This phenomenon can be one of many reasons why a stock might fall with good news and is often seen with stocks releasingearnings reports.
Valuing a Stock
Determining the value of a stock in the public market is a combination of science and art. Analysts are paid hundreds of thousands of dollars each year to follow stocks and determine their value. They usually do this through any of several standard methods with discounted free cash flow valuations being the most common. Alongside these valuations though are also market trading factors and economic influences which can also simultaneously affect market values. So in general there may be several reasons why a stock could fall with good news. Standard valuation methodologies and analyst rating notes are usually part of the science but other factors can also makeup the art.
Earnings Reports
Publicly-traded companies are required by the Securities and Exchange Commission to publicly report earnings results quarterly, four times a year. While this provides a great deal of transparency it can also lead to a build up of rumors as there is a three-month gap between each release. Moreover, any substantial discrepancies from expectations or any drastically surprising announcements will also influence a stock’s price.
As a science, the modeling of a stock’s price is based heavily on the estimated expectations and actual results investors and analysts have for the firm'searnings and cash flows, both now and in the future. When a companyreleases an earnings report, a fundamental reaction is often the most common. As such, good earnings that miss expectations can result in a downgrade of value. If a firm issues an earnings report that does not meetStreetexpectations, the stock's price will usually drop.
Other situations may also occur around earnings. For example, let's say analysts expect XYZ Corp. to reportearnings per share (EPS)of $0.75. Say thecompany announces EPS of $0.80, beating expectations by 6.7%, yet investors respond by selling shares. While the news was "good," perhaps investors expected more. For instance, if thefirm has a history of beating estimates by 10% or more, this relatively smaller beat may be seen as a disappointment. With this scenario, investors may also decrease their appetite for the stock resulting in a lower price to earnings ratio.
Furthermore, perhaps you've heard of something called thewhisper number. This can refer to the collective expectations of individual investors, based on their own analysesof company fundamentals and/orfeelings about a sector or stock,that is not published like analysts expectations are.Whisper numbers can be significantlydifferentfrom the consensus forecast. Let's say in the example above, the whisper number for XYZ Corp. was $0.85 per share. By reporting $0.80 per share, the company fell short of what investors were expecting despite beating analysts' expectations.
With each earnings report, companies usually also provide some future guidance. Future guidance is also a big factor for fundamental valuations. Future guidance provides investors and analysts with management’s insight on the projected future growth as well as any new developments that may affect the fundamentals. A company may release results that match or exceed the market’s expectations but with that they may also include revisions to future estimates that can be a valuation detractor. Any downward revisions to future sales, earnings, cash flow, and more could lead to concerns over the stock’s future value. Downward revisions or developments that decrease future value expectations can be a fundamental reason why a stock might fall alongside good news.
Supply, Demand, and Trading
The Efficient Market Hypothesis suggests that markets are efficiently priced based heavily on their fundamentals. However, regardless of the fundamentals of a stock, there may be plenty of times when a company meets or even exceeds analysts' expectations, provides solid guidance, and sees the share price fall anyway. When this happens, supply, demand, and trading factors may be the catalyst.
Good or bad news about a company often leads to short-term stock price changes and higher short-term volatility.
Like previously mentioned, stock valuation can be both a science and an art. The art of valuing a stock is often influenced by trading factors. The market’s largest stocks have market capitalizations as high as $1 trillion. These stocks also see average daily trading volume of 25 million shares per day or more. In contrast, smaller cap stocks will also see many of the same influences as large-caps but they may be more inclined to show greater volatility with big stock lot trades. Overall, a stock’s market presence and daily trading activity on any given day will also affect its value.
Another possible explanation for a sell-offfollowinggood news can be related tonoise traders. The termnoise trader is generally used to describenon-professional investors, but it mayalso include technical analysts. Noise traders donot analyze thefundamentalsof a prospective investment, but insteadmake trades based on news,technical analysisindicators, or trends. They are often thought of as impulsive and may overreact to good or bad news. So, if XYZ Corp. begins to sell off after a positive earnings report, as described above, noise traders may jump aboard, exacerbating the down move.
Economic and Sector Influences
Lastly, external influences can also be a big factor. These influences can be broadly divided into either macro or micro. Macroeconomic factors like rising interest rates or a market shift to lower risk investments could potentially cause stocks to fall across the board and specifically result in stock losses for a single stock despite good news. Sector influences can also be important to consider. Within the microeconomic environment for a specific sector there may be simultaneous developments detracting from a particular stock or sector’s growth despite the release of good news about the company. Moreover, positive gains or interest in a rival company within the same sector may stifle gains of a stock, even with the announcement of good news.
The Bottom Line
There are many possible explanations for a stock's value decliningdespite good news being released. Oftentimes, investors can discern stock moves based on both the science and art of its valuation. As such, study and awareness of all the possible factors can be important for gauging any potential moves or volatility following good news.
Broadly though, one of the most important things for an investor to do is remain calm and consider both the time frame for your investmentand the reason you boughtthe stock in the first place. Stocks can see a lot of short-term volatility following any new announcements and particularly announcements that are surprisingly good or bad. If a stock holding is part of your long-term portfolio, it can be important to revisit or potentially change your investment thesis with new announcements and developments. If the release of good news remains inline with your investment thesis and a sell off occurs, it just might represent a buying opportunity for you and a chance to add to your long position at a relatively low price rather than selling with the crowd.
