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Dear friends,
In this newsletter, I will go over why stock prices go up and down in the short term. It can be scary for investors when they purchase a stock and see it go up and down in price. This is especially true, if they do not understand why stock prices move up and down.
Okay, so we first need to define what investing in a stock actually is.
When you invest in a stock, you are investing in an actual company. A share of stock is equal to ownership in that company. Some people think that a stock is just gambling on some random stock symbols. This couldn’t be farther from the truth!
You have to remember that a share price moves every few seconds due to the supply and demand in the market. Therefore, when a stock price goes up and down, what really changes is the price that investors are willing to pay to own a piece of the company.
With that in mind, we will go over 7 reasons why stock prices go up and down!
1. Market Correction
A stock market correction happens about every 8-12 months and last about 54 days.
When this happens, it’s normally due to the market being overvalued at that time and looking to come down to reality.
This one might seem pretty obvious, but it is very hard for people to grasp in the moment.
I tell people to look at it like this:
We know the stock market has averaged 10-12% a year since 1957.
If the stock market has a year where it averages +30%, guess what needs to happen? We will get a down year soon to keep the 10-12% average.
If the stock market has a year where it averages -30%, guess what needs to happen?
We will get a big up year soon to keep the 10-12% average.
This is all just simple market corrections.
2.Earnings Report
Publicly traded companies in the U.S. have to publish earnings on a quarterly basis every year. This provides transparency between the company and the business.
Wall Street analysts come up with their estimates about the performance of a company. If a company beats expectations, the stock price will go up. However, if a company fails to meet these analyst estimates, the stock price could get hammered in the short term.
For example, Netflix failed to meet analyst estimates last earnings, and the stock is down -47% since last earnings.
However, I will be sending out a newsletter to our premium subscribers about Netflix in the coming days that is a must read!
3. Dividends Changes
Dividends are payments given to shareholders in the forms of profits.
These payments are not mandatory and can be increased, decreased, or eliminated at any time.
If a dramatic change happens to the dividends then the stock will have a positive or negative impact!
For example, if a company cuts their dividend this usually means the company is struggling with cash. If they do not have extra cash, they cannot pay the dividends. This will cause the stock to go down!
If a company raises their dividends this usually means the company is in great financial shape. This would be a reason that the stock goes up.
However, sometimes companies have raised a dividend even when they couldn’t afford to do. If a large amount of people realized this then it would cause the stock to go down.
4. News on products/services
Information and news surrounding the products and/or services offered by a publicly traded company almost always has an impact on the share price.
As an investor, you should always pay attention to any product/service releases and recalls for companies you may be invested in.
Based on your knowledge of the situation and the company, you ultimately want to decide whether a product/service release or recall is something that gives way for more buying opportunity, or something that acts as a warning sign for poor management decisions.
For example, Chipotle stock was crushed when there was a major recall on their lettuce due to E.Coli. The news went viral, so people started selling Chipotle stock.
However, nothing in the company’s financial health or core business model changed. This was just a temporary public relations problem for Chipotle that was largely forgotten over time. Instead of selling your stock, the best decision at the time would have been to hold the stock and purchase even more on the discount. The stock has doubled since this “scandal.”
5. Acquisitions
If a company is acquired by another company, it's pretty much guaranteed that the share price will move as well. Usually, this is good news for investors but you can never say this for sure.
The stock being acquired will usually go up.
For example, if the stock is trading for $10 but being acquired for $30, it will go way up.
However, depending on how investors feel about a particular acquisition, this may not be the case.
For instance, if a company with a lot of debt acquires a company with even more debt, even if the acquisition appeared to be strategic, investors are likely not going to be happy with the company taking on additional debt.
6. Management Changes
If Elon Musk left Tesla, what do you think would happen to Tesla stock on the announcement? It would go way down.
If Elon Musk became the CEO of a random company, what do you think would happen to the stock of that company? It would go way up.
Without a strong management team, a company will lose its competitive advantage over time and its share price will suffer.
Whenever there are changes in a company's management, expect the stock price to move in some way.
In many cases, changes in management are good things for investors but this is not always the case.
7. Other Bad News
There are a number of other types of bad news events that can send the share price falling fast. This includes scandals, accounting errors, SEC investigations, data breaches, and more.
You ultimately have to look at the situation and determine for yourself whether or not you want to be a shareholder based on this bad news.
One example of this is with the Facebook-Cambridge Analytica scandal in 2018. This was when Facebook was exploited by Cambridge Analytica, a political data analysis firm, and got hold of a massive data set of the American electorate without their permission.
Due to this scandal, Facebook's market value fell by more than $36 billion. However, after this scandal blew over, Facebook was back to trading at "normal" levels.
I hope this helps you have a better understanding of why stocks move up and down in the short term!
I hope everyone has a great rest of the week!
If you have any questions, feedback, or just wanna say hey, email me at mattallenletter@gmail.com
Matt Allen