The timing game is certainly not a good game to play. There are many other games out there for the enthusiasts to play. One is the expectations game. In fact, this is the game that sets prices for stocks specifically, and for the markets in general.
The expectations game
It all starts with some expectations about specific elements of a company which is about to announce certain key information for the markets. For instance, let's take quarterly earnings report. The market would have set certain expectations regarding the company's revenue, margins, operating profit and net earnings in advance of the company's announcement. These expectations are usually based on analyst views and research, news from media and rumors about the company's performance. Of course, there is certain element of insider information out there though it is considered illegal.
It all starts with some expectations about specific elements of a company which is about to announce certain key information for the markets. For instance, let's take quarterly earnings report. The market would have set certain expectations regarding the company's revenue, margins, operating profit and net earnings in advance of the company's announcement. These expectations are usually based on analyst views and research, news from media and rumors about the company's performance. Of course, there is certain element of insider information out there though it is considered illegal.
The short term absurdity
A combination of these factors set the stock prices of the company in advance. After the announcement, the stock prices react only to the expectations compared with the actual performance, rather than to the actual performance directly. It might sound a bit strange, but, it is a fact.
For instance, if the expected revenue growth was 5% and actual growth was 7% the stock price is likely to go up. On the other hand, if the expected operating margin was 10% and actual was 8% the stock price is likely to go down.
The market would not react to the actual performance compared with the past performance. Let's consider this: If the operating margin in the previous quarter or year was 6%, the current margin of 8% is considered to be a better performance. However, because the market has already considered this fact in advance, there would be no reaction to this after the announcement. Oddly, the focus would be only on the expectations and actual. That is why, instead of stock price going up, it would go down.
For instance, if the expected revenue growth was 5% and actual growth was 7% the stock price is likely to go up. On the other hand, if the expected operating margin was 10% and actual was 8% the stock price is likely to go down.
The market would not react to the actual performance compared with the past performance. Let's consider this: If the operating margin in the previous quarter or year was 6%, the current margin of 8% is considered to be a better performance. However, because the market has already considered this fact in advance, there would be no reaction to this after the announcement. Oddly, the focus would be only on the expectations and actual. That is why, instead of stock price going up, it would go down.
The managers who are aware of this phenomenon are ready to participate in the game too. The game gets more interesting: They are more likely to play down the expectations by giving lower guidance for the future, and beating the expectations by better-than-expected performance.
The expectations game is played not only on the earnings performance; we can see it on dividends, debt, equity, acquisitions, divestitures, restructuring, and many other elements affecting the financial performance.
Such is the behavior of the markets.
The recent announcement from Apple was quite good based on the actual performance; yet the stock fell 8%.
The expectations game is played not only on the earnings performance; we can see it on dividends, debt, equity, acquisitions, divestitures, restructuring, and many other elements affecting the financial performance.
Such is the behavior of the markets.
The recent announcement from Apple was quite good based on the actual performance; yet the stock fell 8%.
Reliance stock fell on lower than expected operating profits, though net earnings were above expectations. As of now the company is in the high capex phase, and has plans to increase investments in its energy, retail and telecom businesses. The market is slowly factoring these elements in its expectations, although, the stock price currently does not reflect the expectations game fully. In time, but well before the actual performance, these expectations would have built in the stock prices.
A better game to play
What is crucial though is to realize that these games look good in the short term where the excitement is imminent. However, in the long term the stock prices reflect the fundamental aspects of the operating business of the company. Ultimately, the earning power (i.e. the ability to generate cash flows) of the business impacts its true worth, the intrinsic value. That is why it is better to concentrate on the long term performance of the business rather than the short term. It is also an easier game to play. We should be under control regarding when to buy, when to sell, and more importantly when to keep quiet. Too much of nonsense takes place when there is too much of an activity in the markets.
What is crucial though is to realize that these games look good in the short term where the excitement is imminent. However, in the long term the stock prices reflect the fundamental aspects of the operating business of the company. Ultimately, the earning power (i.e. the ability to generate cash flows) of the business impacts its true worth, the intrinsic value. That is why it is better to concentrate on the long term performance of the business rather than the short term. It is also an easier game to play. We should be under control regarding when to buy, when to sell, and more importantly when to keep quiet. Too much of nonsense takes place when there is too much of an activity in the markets.
Those who have the virtue of patience and are adept at the liquidity game, i.e. are able to withstand short term crashes in the stock prices by not selling due to panic, should come out as winners.
It's going to be fine in the long run for someone who has done the homework right and behaved right.
It's going to be fine in the long run for someone who has done the homework right and behaved right.
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