Why do stocks that beat earnings expectations fall the next day? So if I am invested in something that I think is going to be expectations should I sell my position the day of earnings?
In: Economics
They don’t always fall – they only fall if they don’t beat expectations by as much as was expected.
A stock price (theoretically) incorporates all publicly available information. Analysts will look at a company ahead of earnings announcements and calculate what they _believe_ the earnings announcement will say. Based on that calculation, they will buy/sell the stock, and over enough trades the price will settle at a new value which incorporates that estimation.
When the earnings are announced, earnings are no longer an estimation – they are fact. The factual earnings will be plugged back into that same calculation, a new target price determined, and new trading activity based on whether the new price is higher/lower than the previously price based on estimations.
So, in the real world, if ABC Corp released estimates that EPS will be $5, and I do some math and think that it should actually be $6, I’m going to buy a bunch of shares, which will drive up the price. If ABC announces actual EPS of $5.50, they may have beat expectations, but they didn’t beat _my_ expectations, so I’m going to sell.
A lot of it is that there’s extra information that comes out during the earnings reports. So maybe they beat expectations this quarter, but they also report that they expect lower earnings in the next 1-10 years. So the bad news outweighs the good news.
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