Watching firms rise and fall on the stock exchange, it’s natural to assume that good news for a corporation, like the announcement of record profits in the last quarter, should immediately be echoed by an increase in the corporation’s share prices. Because this seems so intuitive, market watchers can be taken by surprise when, as often happens, share prices actually fall despite forecasting or even reporting record profits. This seemingly paradoxical market behaviour usually occurs because of profit-taking by investors who begin to sell out because they fear the stock may not climb much higher, or because of alarm by investors who were expecting even higher revenue projections.
The reasons for this behaviour lie in how the stock market actually works. When a corporation’s shares are traded on a public exchange, the value fluctuates according to what investors believe the company’s likely performance will be in the future. The “share prices” that are released regularly are the prices at which the markets are able to bring together both shareholders willing to sell and prospective investors hoping to buy. When share prices fall, this is an indication that either there are too many shareholders, too few buyers, or both, for trading to be sustained at the higher price. Essentially, say analysts at the Marriott School, the basic economic principles of supply and demand apply to stocks in the same way as any other assets, goods or services.
Normally, a forecast of record profits would be a signal that a firm is performing well, and such an announcement could result in there being fewer shareholders willing to sell and more investors hoping to buy in. In that case, the share prices would rise on good news. Quite often, however, financial writer Dan Coatsworth of “Shares Magazine” says that shares actually “fall on good results.”
One of the most important reasons for this unexpected behaviour is that investors actually welcome the news of record profits, but are still concerned about the future of the corporation. It is important to recognize that intelligent, forward-thinking investors do not invest simply based on the performance of a company today, or over the past quarter. Instead, they invest based on what they suspect the company may do over the next several years. To that end, large investors will probably already have factored expected earnings into the price of the stock before an announcement about quarterly results, or a forecast of upcoming results. Sometimes, even if the the new forecast calls for record profits, those profits will still fall short of what the more optimistic investors were hoping the company would earn. As a result, they adjust their expectations downward and begin selling stock.
A similar response can come from those who welcome the news that the company has earned record profits, but fear that the record-setting performance will not continue. Perhaps this is because of more fundamental, long-term problems with the company’s position in the market. These investors may see a forecast of record profits as a good time to begin selling their stock. They do this so that if prices fall in the future, they will have cashed out while the stock was at or close to its peak. These sorts of large sell-offs by skeptical or pessimistic investors can trigger a downward slide in the share price.
In July 2013, market watchers could see this sort of thinking at work in the way investors responded to an earnings announcement by Samsung Electronics, a leading South Korean technology company. Samsung reported record profits of $8.3 billion over the last quarter. This was an impressive figure. However, analysts were expecting the profits to be even higher, perhaps $9 billion or so. Samsung is in an extremely competitive economic sector and faces increasing competition from Chinese technology companies. As a result, Samsung share prices fell even on news that the firm had earned record profits.