How Events affect Perception and Investor Confidence

There are times when a company's earnings history and projections are the only solid data that you have on which to base a decision about its stock. Although that may be enough, you must nonetheless constantly monitor your stocks for events that can change either a company's market perception or investor confidence; because, as we learned in the article Why do Stock Prices Move?, these two factors are crucial to price changes and the valuation of every stock.

Let's take a look at just a few events that can change the perception of a stock's future earnings and the confidence level about those earnings. The different strategies that you may use in implementing your investment program should closely monitor these factors.

Earnings announcements. A company's quarterly earnings are the primary factor in altering market perception and investor confidence, although the direction of the change may not always be what's expected. For example, the just-announced earnings figures could actually be record-setting, but the market may have expected an even larger number, one based on 'whisper numbers' (which are those unofficial earnings estimates that are spoken of by brokers and analysts in phone calls and informal settings a week or two before a company's earnings announcement is released; although unofficial, these figures are the market's true expectations of the company's earnings). Consequently, what appears to be positive news is perceived as negative, and the stock price declines. A company's failure to meet its whisper numbers is often viewed as an early warning that future earnings and the accompanying expected growth rate might not be reached. However, if a company announces earnings that meet or exceed the market's expectations (especially if it has a history of doing so), the perception of a strong future along with investor confidence that it can be achieved can boost a stock to record levels.

Revising estimates. One of the most accurate forecasters of positive or negative moves in a stock's price is the one-month change in analysts' estimates. Generally speaking, the first research report written by an analyst is positive. This is due to the fact that, frequently, the analyst is performing his or her duty to the firm and looking for good things to say. A revision of those estimates, however, is quite meaningful because it requires a separate initiative by the analyst to admit that he or she was wrong or simply had a change of mind. An upward revision in earnings estimates will likely produce a positive change in the price of a stock. However, a downward revision will tend to have an even more dramatic effect on the stock price than an upward revision; in fact, it could be devastating. It takes a great deal of courage for an analyst to lower an estimate, because in many cases he or she is saying something negative about a client of the firm. Additionally, the number of analysts who make a revision is also highly significant. Several analysts raising or lowering their estimates will have a much greater impact on a stock than just one analyst issuing a revision.