Why Do Stock Prices Drop After Beating Earnings?

It's a question that has puzzled stock market investors for years - why do stock prices drop after beating earnings? On the surface, it seems like good news - the company has performed better than expected, so why would the stock price go down? Many analysts have tried to answer this question, but there is no one definitive answer.

Some people say that it's because expectations are now higher for future earnings reports, while others claim that investors simply take profits after a good earnings report. Whatever the reason may be, it's something that all investors need to be aware of.

Lets start with lowered guidance. A company can post an earnings beat while also lowering their earnings guidance. i.e. During the earnings report, they could lower their predictions for future sales or profits. This lowered guidance can frighten investors and lower the share price.

For example, Nokia’s 2020 Q4 earnings beat estimates. However, the company also warned that 2021 would be a challenging year. Mostly due to the fact that it is facing market share loss and price erosion in North America.

As a result, the share price in Nokia continued to drop.

Another reason can be because “profit taking” is so prevalent after a good earnings report, many traders feel as though they need to sell before other traders begin to sell. If I think that other traders are going to lock in their profits and drive the price down, I am more likely to sell myself. Then, if it does drop, I can simply buy it back on the dip. If it doesn’t drop, who cares? I made my profit and I can simply move onto the next stock.

An other reason can because of hedge funds. The volume after a company reports earnings often provides large hedge funds with the opportunity to exit a large position without knocking down the price of the stock. If the ER is a beat, then there will be plenty of buyers to prop up the price and help them unwind their position.

As traders take their profits and the stock price declines, a sense of panic begins to set in. This leads to further selling and a steeper decline in the price of the stock. Remember: The market isn’t always rational as traders will often make decisions based on their emotions. The long term fundamentals of a company might not matter to someone who is watching their profits evaporate by the minute.

If you take the factors above into account, you can easily see why a stock can drop after an earnings beat. Fortunately, if the fundamentals of the company are strong and there isn’t any cause for concern, the price will often bounce back in the short-mid term.

When a stock price drops after an earnings beat, it can be confusing and frustrating for investors. However, if you take the time to understand the market and the factors at play, you can see that there is often logic behind the decline. Keep calm and stay informed, and you’ll be able to weather any storms that come your way.