In this article, I will cover the 12 main reasons on why a stock price may change. After reading through this article, you should be able to apply this information to make more informed investment decisions in the future.
It can be uneasy for new investors when they purchase a stock and see the stock fluctuate up and down in the short-term. This is especially the case if they do not understand why stock prices move in the way they do. This can often lead to panic selling or bad investment decisions. Therefore, it's a good idea to understand the dynamics behind price movements, especially in times of economic uncertainty.
Before diving into these 12 reasons, it's crucial that we understand what a stock or share price is and how it functions.
A stock/share price is a representation of the total value of a publicly traded company split up into individual shares.
If you go onto Google or Yahoo Finance, two great platforms for quickly searching stocks (besides the brokerages you may use), and search for a stock, the price that shows up (in big/bold font) is likely the share price. You may notice that this price changes every second.
What you should remember, is that the share price moves every few seconds due to the supply and demand in the market. Therefore, as you watch a stock price and see it go up and down, even one cent, what really changes is the price that investors are willing to pay to own a piece of the company.
With this in mind, we can now cover the 12 reasons on why a stock price may change.
Reason #1: Market Corrections
Stock prices can change significantly from a market correction.
"A rising tide lifts all boats."- Old Chinese Proverb
On an average historical basis, these stock market corrections occur about every 8-12 months and last about 54 days.
You can see how often corrections have happened in the past with the chart below:
When a market correction happens, there is usually no reason for concern. It's just the fact that the market has corrected, or it may be a more specific industry correction.
If you see that your share price has changed out of what is normal, the first place you should look is the S&P 500 Index (SPX), NASDAQ Composite Index (COMP), or Dow Jones Industrial Average (DJIA). These are the three most-followed market indices in the U.S. Look at one of these indices and see if there are multiple percentage losses (or gains). If the company you've invested in follows the market, given no other circumstances (such as those listed later in this article), in most cases this is likely not a case for concern.
An example of this can be when the Dow (aka; DJIA) fell 1000 points on February 24th, 2020 due to coronavirus fears. On this date, almost every stock in the market was down. This had little or nothing to do with the individual stocks themselves but had more to do with the broad market correction and uncertainty investors were feeling at the time.
Sometimes, you'll see that the company you've invested in does not follow the overall market. Among other reasons, this may be due to the industry you're in. You can find indices that track particular U.S. industries (e.g., iShares U.S. Technology ETF (IYW) for tech stocks), and when an entire industry market correction occurs, often times there's no real reason for concern. It's simply a larger movement going on in the industry that your stock is getting caught up in.
Now, what would be reason for concern is if you see your stock deviating from what the market is doing, especially if this is on a regular basis. In other words, if the market has been bullish for sometime but the stock you own is not performing as well, and is most certainly heading in the other direction, this would be reason for concern and is likely not a market correction taking place. In this case, I would look into the company and attempt to find the reason for this poor performance.
Reason #2: Earnings Reports
Publicly traded companies in the U.S. have to publish earnings on a quarterly basis every year.
You can view the earnings calendar and estimates for all publicly traded companies in the U.S. HERE.
You can also find this information for individual companies by searching: "name of a company + investor relations," and then find the investor relations section on their website. This is where you can find earnings reports and other important company announcements such as annual reports.
Before these earnings are available to the public, "wall street analysts" come up with estimates on how they expect companies to perform. If a company beats these analyst expectations, it usually sends the stock up. On the other hand, if a company fails to meet these analyst's estimates, a drop in the stock price usually follows.
More often than not, the day before, on, and after companies release their earnings reports, their stock will naturally tend to be more volatile. You should therefore keep track of when your company's earnings reports are released to avoid making any poor investment decisions.
Furthermore, although it may seem like a stock price would always increase after a company beats analyst estimates, this is not always the case. In fact, a stock performing extremely well and beating analyst expectations may scare off investors and a sharp decrease in the stock price may happen the day earnings are announced. However, this is not usually the case for earnings reports that fail to beat analyst estimates.
Good News Gets Priced in
Often times, if a company is expected to beat analyst estimates by the general public, this earnings beat is already "priced in" before the earnings report is even released.
"Priced in" just means that a company's stock price has already taken into account all the factors that can potentially affect the company in the near future.
In other words, if a company is expected to perform extremely well with their earnings, and all of the analysts are bullish (they expect the company to do well), it's possible that this beat of earnings is already priced into the stock. This is simply because people expect it to happen! Therefore, you should never assume that a beat in expectations will send a stock soaring. In fact, betting on earnings is usually high-risk, and is not something I would recommend doing.
Forward Looking Guidance
Some companies also choose to offer forward looking guidance, where they'll set benchmarks as to what they aim to hit for measures such as revenue, profit margin, units sold, and more.
Changes to these guidance figures can therefore send the stock in either direction too. Note that not all companies do this, as some decide not to.
Reason #3: Dividend Changes and Payments
Dividends are small payments given by typically larger companies in the market to shareholders, simply for holding their stock. These dividend payments are not mandatory whatsoever, and can be increased, decreased, or eliminated at any time.
Fortunately, many dividend-paying companies have consistently paid out dividends for several decades, partially to reward investors but primarily because they do not have as much growth potential as less mature companies with more growth potential. So, in many cases, this dividend acts to keep investors invested in the company.
Dividend changes and payments almost always result in a movement of the share price. I say almost, because with the stock market, logic sometimes tends to go out the window.
For dividend changes, if a dividend-paying company announces that it'll be paying out a much lower dividend, or if the company announces that it'll no longer be paying out dividends, it's very likely that the stock price would fall substantially. This is especially the case if the company has been paying out dividends for a long time.
General Electric (GE) is a company that went from being a good dividend stock to cutting their dividend to pennies, essentially eliminating the dividend. Regardless, as a general rule, if you own a dividend-paying company, notice its share price falling substantially and dividend yield growing to the double digits (or even above 8%), run far far away!
You may receive a high yield dividend for one or two quarters but the truth is that these companies are likely facing internal hardship and they likely won't be able to afford to pay out this dividend much longer.
Stock Prices and Dividends
After a dividend-paying company announces a dividend, investors invest into the company before the "ex-dividend date," perhaps at an overvalued price, to profit from the dividend when it's eventually paid out.
This generally causes the price of a stock to increase until the dividend is actually paid out. Afterwards, a small decrease in the stock price typically follows, which is about equal to the amount of the dividend being paid out (to all of the company's shareholders). Therefore, if you own a dividend stock, do not be alarmed by these price movements near the ex-dividend dates.
Reason #4: News on Products and/or 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.
Product Releases and Recalls Examples
Here are three examples of product releases and recalls in the past:
- Chipotle's lettuce recall for E.coli bacteria
- Johnson & Johnson baby powder lawsuit
- GoPro's Karma drones GPS glitch
First, for the Chipotle (CMG) lettuce recall, a very microscopic number of people actually got E.coli in their lettuce. However, this was in the news everywhere and Chipotle's stock price was relatively volatile during this period until the issue was eventually resolved.
Given nothing in the company's overall financial health or core business model had changed, and because this was likely a temporary problem affecting Chipotle's image (which would be forgotten overtime), the better decision at the time would've been to continue holding onto the stock and to even purchase more of the stock at lower discount prices.
The same can be said for the Johnson & Johnson (JNJ) baby powder lawsuit, where some investors at the time felt inclined to sell their JNJ shares immediately. However, these investors failed to realize that JNJ is a multi-national company with hundreds of products. It's also one of the most established companies in the U.S. Therefore, this lawsuit situation was likely an obstacle they could overcome.
GoPro (GPRO) is one company whose stock price has not performed well since its IPO in 2016. One major reason for this poor performance has been because of its lack of attractive consumer products.
In the case of GoPro's Karma Drone, GoPro was forced to recall these drones due to a "GPS glitch" which upset investors and consumers alike. So, in this case, given GoPro's poor past performance and product recall failure, holding onto this stock would not have been a wise idea at the time.
Reason #5: Employee Layoffs
Company layoffs and restructuring are not always a bad thing. Often times, it's a sign of a company consolidating or maybe even making their balance sheet more attractive.
Some businesses out there are in cyclical industries where the demand comes and goes. In other words, a company may experience massive demand for their products and/or services for one period of time, but may struggle to make sales in other periods of time simply due to the nature of the business. This cyclical nature can therefore be a reason for companies to layoff employees.
An example of this can be the airline industry, and how in good economic times more air travel is common, whereas in poor economic times, travel is a lot less frequent. This lack of consumer spending in the airline industry can therefore lead to large amounts of layoffs.
Wall Street typically reacts negatively to new layoffs within a company. Layoffs may indicate consolidation and shrinking. In particular, if a company has massive layoffs, this could significantly reduce the innovation and research being done within the company. Eventually, this may lead to the company falling out of favor in the market.
Reason #6: 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.
Typically, if you are holding a stock that gets acquired, the capital appreciation on that stock you're holding will increase. 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.
As you can imagine, there are always different ways to interpret the news of an acquisition.
Public to Private
This does not happen very often, but it still does occur every once in a while. Typically, companies go from private to public (i.e., through an initial public offering (IPO)), not public to private. However, public companies are sometimes taken private after acquisitions.
In April of 2017, A German company called JAB Holdings announced the acquisitions of Panera Bread (previously: PNRA). They would be buying out the company and taking it private at $315 per share. So, if you were a shareholder at the time, you would have received $315 per share of Panera stock you owned.
Companies also typically pay a takeover premium when acquiring a company. This is expressed as a percentage above the current market value.
When JAB Holdings purchased Panera Bread, they paid a premium above the current share price. As a result, this is almost always good news for investors when a stock they own is taken private. Therefore, although it's rare, if you ever own a company and it's taken private you'll likely have a great day.
Reason #7: Stock Splits
More often than not, if you find out a stock you invested in is getting split, it's a good sign for you.
Companies may choose to split up shares into smaller chunks when the share price becomes out of reach for average retail investors. However, in this era of fractional share investing, this may become less common.
One example of a stock split was when Apple completed a 7-1 stock split. This 7-1 stock split made one share of Apple, worth $645.54 on market close, to $92.70 the next trading day. So, for every share of Apple that you owned, you now received 7 shares.
When stocks are split, you should not think of the stock as a "bargain stock," as the value of the company did not change whatsoever. In other words, the shares one owns before and after a stock split is worth the exact same. A stock split only makes the share price more accessible for smaller investors, which ended up working well for Apple.
A stock split is a good sign because you may be getting a 2-1, 4-1, 5-1, or whatever stock split. This makes the share price more accessible to smaller investors who may think a lower priced stock is a more reasonable buy, even though the stock's underlying value did not change whatsoever.
Reverse Stock Split
Just as shares can come apart, they can come back together as well. When shares are being glued back together or consolidated, this is almost always a bad sign.
The reason companies have reverse stock splits is because companies that trade on the NYSE and NASDAQ have to adhere to certain listing requirements. For example, if the share price gets too low, they can get de-listed from the stock exchange. In order to avoid being de-listed, a company can complete a reverse stock split and consolidate many shares into one.
These companies are typically not doing well at all and are forced to either do a reverse stock split or face trading on a less desirable over-the-counter stock exchange.
Reverse Stock Split Example
To better understand how reverse stock splits function and why they're generally bad for investors, here is a made-up example scenario...
Company XYZ has an initial public offering (IPO) of 100,000 shares at $10 per share, giving them a market capitalization of $1,000,000. In order to remain listed on a major exchange, they need to maintain a share price above $1. Unfortunately, things do not work out for Company XYZ and the stock is now trading at $0.50 a share.
If they do not get the share price above $1, they will be de-listed by the end of the year. Management then has a discussion and agrees to initiate a reverse split in a 5-1 ratio. This reverse split is voted on by shareholders as well and passes.
Now, each shareholder will receive 1 share per 5 they once had. Before the split, Company XYZ had a market capitalization of $50,000 (100,000 shares x $0.50 per share).
After the split, the shares outstanding are reduced to 20,000 (100,000 shares / 5) and the market capitalization does not change. As a result, each share is now worth $2.50 ($50,000 / 20,000 shares outstanding) after the consolidation. Now, Company XYZ can fulfill the listing requirements. However, this does not fool investors, and the announcement of the reverse split results in a 5% sell off.
Reason #8: Management Changes
Without a strong management team, a company will lose its competitive advantage over time and its share price will suffer. So, 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.
More often than not, when higher-level management changes, the stock price will fluctuate more than if a lower-level management position is replaced. One example of this is when General Electric (GE) dumped John Flannery as CEO. In this case, investors reacted positively to this news, as they likely agreed with the board's decision and reasoning behind his removal.
Reason #9: 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. This is not an answer anyone can answer except you! Often times, bad news gives investors the chance to take advantage of the pessimism in the market. In other words, investors frequently purchase stocks when they are at a lower price due to the short-term dips that follow major bad news events.
One example of this is with the Facebook (FB) 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. Cambridge Analytica may have also been used by the Trump campaign in 2016 to target voters.
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. Although further research was required at the time of this scandal, Facebook, in general, is a well-established and great buy-and-hold company. So, when this stock fell significantly, one could have purchased the company knowing its fundamentals were still solid.
Another example of a data breach where the stock price fell significantly and returned to "normal" levels is with Equifax's data breach in late 2017.
Reason #10: Interest Rates
Interest rates can have a huge impact on the stock market, as changes in the interest rate will have an affect on the spending decisions made by consumers and businesses across the nation.
Put simply, interest rates have the ability to increase or decrease the growth of the economy. You can think of low interest rates as pushing down the gas pedal and the economy accelerating ahead. High interest rates, on the other hand is like slamming on the brakes and slowing down the economy.
The Federal Reserve (aka the Fed) uses the federal funds rate as a gas pedal and brake for the overall economy. The federal funds rate, as shown in the image below, is the interest rate at which money is loaned to the banks. So, when a bank borrows money from the Federal Reserve and loans this money to you, the rate that is paid to you in a savings account, and even rates paid on mortgages, are based on the federal funds rate and are subject to change.
In short, you should keep in mind that lower interest rates are equal to cheaper prices and a stimulated economy.
One example of a drop in the interest rates was in 2008 when we had the housing market crash. The Fed dropped the interest rate to zero to artificially stimulate the economy because of how bad things were at this point in time. As the economy began to recover, the Fed eventually began increasing the interest rate so that hyper-inflation didn't take place.
In short, altering the interest rate significantly is going to have a major impact on the stock market. With lower interest rates, or the Fed stating that they will not increase interest rates any higher, a well-performing stock market is more likely.
On the other hand, with higher interest rates, there is less borrowing incentive, and growth is discouraged. In this case, you will likely see a correction happening in the stock market.
Reason #11: Unemployment
The unemployment rate, as shown below, is typically a good overall indicator of how the economy is doing:
When we're in a roaring or booming economy there's lots of hiring and low unemployment. Employers are looking to invest in research and development, and as a result, hiring takes place. On the other hand, when there's a contracting economy you're going to see companies laying off employees, companies missing earnings reports, profit margins falling, and high unemployment.
As a result, in times of higher unemployment the stock market may become more volatile and may tend to form more bearish patterns.
Reason #12: Politics
Politics has the potential to have a big impact on the stock market. For example, when Trump was elected in 2016, the market went into a sell-off (which then quickly rebounded) as this news was surprising to many Americans.
Aside from major political events, every politician has an agenda, and changes to government policy can either positively or negatively impact the economy. For example, corporate tax cuts under the Trump administration have had a positive impact on the overall economy as corporate earnings have soared.
Therefore, you should be aware of the political scene, the major actions government takes, and the policies being enacted to make better informed investment decisions.
The Bottom Line
These 12 reasons on why a stock price may change should have given you a broad understanding of the stock market and individual stock prices, and why their prices may fluctuate over the short-term.
In short, much of why a stock price changes is due to news, overall market movements, or individual company changes such as with dividends, earnings reports, and management changes. Therefore, to avoid making poor investment decisions in the future, it's best to follow the overall markets and news events, company announcements, and economic measures such as the interest rate, inflation rate, and the unemployment rate.
Ultimately, if you are to follow these items on a regular basis, you can better understand movements in stock prices, which should enable you to make more informed investment decisions.