Why Is it That Stocks Sometimes Go Up on Bad News?

It's an interesting phenomenon.

A stock will come out with worse than expected earnings and actually end up going higher on the news. What gives? Why would a stock do that?

The answer is that usually, the news was bad but not as bad as expected. Or maybe their earnings number was bad, but some other component of their earnings report was stronger than expected. This is why if you are shorting a stock after it reports poor earnings, you had better be extremely intimate with the finer details of the company, or else you stand the risk of losing on your short.

Companies oftentimes have "whisper" numbers. This is the number that Wall Street analysts privately think that the company could post, and oftentimes this number is much different than their publicly projected number. Analysts are normally publicly conservative, but privately they can have either higher or lower expectations for a stock.

So let's say that a company is expected to post a loss of 40 cents in the quarter, but analysts believe that it could be worse than that, and they have a whisper number of as low as 45 cents per share.

The company comes out and posts a loss of 41 cents per share. Now, you might think that this would cause the stock to drop, but since they actually beat the whisper number, the stock could actually end up going higher on the news.

Also, let's say that a company expects a loss of 40 cents per share on revenues of $880 million dollars. The company posts a loss of 44 cents per share, but revenues come in at $950 million dollars, and the company announced that they will be hiring a new CEO.

You may expect the stock to drop on this news, but analysts and investors may look at that revenue number and actually send the stock higher. Or it might be sales in Europe, or profit margins, or a number of other things. You can't just look at the earnings per share to determine whether or not a stock will drop, there are more factors involved than that.

In the end, the reason for a stock to trade higher on bad news normally indicates that the news wasn't as bad as expected, or perhaps there was a nugget of information in the earnings report that provides some optimism for the future.

If you are going to short a stock after it posts an earnings report, make sure you are very familiar with the company.

Filed under: Stock Market Education | General Knowledge