The quarterly show and tell can move the market and individual issues up or down depending on the reports.
How well companies did in the past is predictive of the future. Investors and analysts scour the reports discounting one-time events such as the sale of a division.
Earnings must relate to the stock’s price or something is amiss.
For example, if stock’s price is trending down (as in a bear market), yet a company’s earnings are holding steady or rising, the investor needs to ask why.
Are there problems ahead that are not reflected in the last quarter’s earnings?
Likewise, if a stock is climbing, but the most recent earnings report shows weakness or worse, investors may decide the stock is over-priced and sell (sending the price down).
You can see the interesting relationship between current price and past earnings.
A stock’s price usually looks ahead, anticipating future results. If the most recent earnings report comes in higher or lower than anticipated, investors must readjust expectations of future results.
In other words, when past performance does not justify anticipated stock prices, something must change – namely the stock’s price.
Bump or Dip in Stock Prices
This accounts, in part, for the sometimes bump or dip in prices when earnings are announced.
This all sounds logical and analytical, and most of it is, however, you can’t discount the role emotions play in stock prices.
During strong market trends up or down, responses to earnings reports (and other market and economic indicators) can be exaggerated.
Remember the dot.com boom, when companies with barely a viable product and no earnings in sight were market superstars.
When the market came to its senses, prices crashed because there was little of substance to support what investors were paying for stocks.
Likewise, during the market meltdown of 2008-09, prices fell perhaps farther than was justified as investors panicked and fled the market.
The lesson is that regardless of what emotional reaction the market makes to good or bad conditions, sooner or later it will self-correct prices.
This self-correction is far from perfect and may swing to far one way and then swing back again.
Within this market action is opportunity for investors who can sort through the emotion and corrections. Some stocks will over-correct and others may under-correct.
Smart investors will spot these opportunities for buy or sell orders.