Conventional wisdom dictates that when a company beats Wall Street's earnings estimates for a given quarter, its stock price should rise. But that's not always the case. In many instances, a stock's share price declines after better-than-expected earnings are reported.

Investors need to know that there is a reason for the decline in share price. It just might not be an obvious reason.

There are five major reasons for why a share price declines unexpectedly:

1. Major Shareholder Selling
Some institutional shareholders set a target to sell their stock at a given price or if a certain event transpires. The end result is that the supply of shares available for sale (after the event transpires) usually depresses the share price.

How can the average investor tell if a major shareholder is unloading his or her position? The answer can be found in the individual trade volumes on the tape.

For example, while individual investors typically make trades in the hundreds or low thousands of shares, institutions such as mutual funds often sell stocks in the tens of thousands of shares - or, even in rapid fire in low volumes of 3,000 or 4,000 shares.

So take a look at the tape and try to determine whether institutional selling is indeed driving down the share price. Once the selling is over, assuming the company's fundamentals remain intact, the stock price often jumps back up again fairly quickly. This creates a great buying opportunity for the long-term investor. (For more insight, read Institutional Investors And Fundamentals: What's The Link?)

2. Research Notes
Sometimes a sell-side analyst will put out a (negative) research note on the company either just before or just after earnings are released. This report (even if it is only slightly negative in nature) can affect the way that firm's clients think, especially those that are more short-term oriented. In any case, as a result of the analyst's commentary, some selling pressure often ensues. (Read more on this subject in Trading On News Releases and What Is The Impact Of Research On Stock Prices?)

While individual investors may have trouble accessing these reports, large newswires will often announce that a brokerage firm report has been issued, or the firm itself may release some information about the existence of the report to the general public. Again, the savvy investor may be able to use this information as a buying opportunity once the selling pressure subsides, assuming that there have been no fundamental changes in company.

3. Not Meeting the Whisper
Oftentimes, a company will beat the average Wall Street estimate, but fail to meet or beat the whisper number and, as a result, its stock price falls. The whisper number is simply an unofficial estimate, or rumor, that is circulating around Wall Street. Besides being aware of what that number is, there really isn't much an investor can do to defend against this. However, it does serve to explain some sell offs. (To learn more, read Whisper Numbers: Should You Listen?)

4. Faulty Numbers
Sometimes, there is a fundamental reason for a stock to fall after earnings are announced. For example, perhaps the company's gross margins have fallen dramatically from last quarter, or maybe its cash position has dwindled dramatically. The company may also be spending too much money on selling, general and administrative expenses (SGA) to pay for a new product launch.

Investors should carefully review earnings announcements to try to determine not only if the company beat earnings estimates, but also how it beat them. Determining the company's financial standing is of the utmost importance, as any shortcomings are bound to be reflected in the share price sooner or later.

Look specifically for any (sequential and/or year-over-year) changes in gross margins and operating margins. Also look for both sequential and year-over-year declines in cash balances. And don't forget to look for large one-time additions or subtractions from net income that could impact the way investors think. In the end, try to review what the analyst community and the media is saying immediately after the earnings are released, as their analysis of the situation may actually highlight an area of concern that you have overlooked. (For further reading, check out Earnings: Quality Means Everything.)

5. Future Guidance
Most public companies conduct a conference call after earnings are released. In this call, management may make forecasts or provide other guidance about the future prospects for the company. Investors need to remember that any guidance that is contradictory to what the investment community is expecting can have a material impact on the price of the stock. (Learn more about these meetings in Conference Call Basics.)

Investors should try to take part in the conference call or at least listen to the replay tape, which is often made available on the company's website an hour or two after the original call takes place.

Bottom Line
There is almost always a tangible reason behind the downward movement in a given share price after earnings are released, but it's up to the investor to play the role of detective and to try to determine what that reason is. Those who are able to decipher the logic behind (and the source of) such market movements may be richly rewarded.

Related Articles
  1. Stock Analysis

    Forest Laboratories: An Activist Investment Analysis

    Find out how patience and perseverance paid off big-time for billionaire activist Carl Icahn during his four-year fight with Forest Laboratories.
  2. Stock Analysis

    Tribune Media: An Activist Investment Analysis (TRCO)

    Learn more about the breakup of Tribune Company, once a powerful newspaper and broadcasting giant, and the role of activist investor Cliff Robbins.
  3. Stock Analysis

    PepsiCo: An Activist Investment Analysis (PEP)

    Read about the nearly two-year public feud between activist investor Nelson Peltz, head of Trian Fund Management, and iconic soft drink maker PepsiCo.
  4. Investing Basics

    5 Common Mistakes Young Investors Make

    Missteps are common whenever you’re learning something new. But in investing, missteps can have serious financial consequences.
  5. Stock Analysis

    Hologic: An Activist Investment Analysis (HOLX)

    Read about a health care company that attracted activist investors Carl Icahn, Barry Rosenstein and Ralph Whitworth at the same time.
  6. Stock Analysis

    Air Products and Chemicals: An Activist Investment Analysis (APD)

    Learn about the productive, and uncommonly friendly, activist investment made by Bill Ackman into Air Products and Chemicals.
  7. Investing Basics

    5 Questions First Time Investors Should Ask in 2016

    Learn five of the most important questions you need to ask if you are a new investor planning on starting an investment program in 2016.
  8. Stock Analysis

    The Biggest Risks of Investing in Verizon Stock (VZ)

    Read about some of the biggest risks of investing in Verizon stock. While the company has a good dividend and value pricing, there are risks.
  9. Mutual Funds & ETFs

    The 3 Best American Funds for Value Investors in 2016

    Learn about value investing and how interest rate hikes benefit mutual funds, and the top three American Funds mutual funds for value investors.
  10. Investing Basics

    How to Pick A Stock

    The first step in picking stock is to determine your goals.
  1. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  2. What is the 'Rule of 72'?

    The 'Rule of 72' is a simplified way to determine how long an investment will take to double, given a fixed annual rate of ... Read Full Answer >>
  3. What is a stock split? Why do stocks split?

    All publicly-traded companies have a set number of shares that are outstanding on the stock market. A stock split is a decision ... Read Full Answer >>
  4. What do states do with unclaimed property?

    Unclaimed property refers to personal accounts in financial institutions or companies that have had no activity and whose ... Read Full Answer >>
  5. How do financial advisors execute trades?

    Today, almost every investor invests through online brokerage accounts. Investors often believe that their trades are directly ... Read Full Answer >>
  6. What are ComputerShare's escheatment services?

    Escheatment is the process by which ownership of abandoned property is transferred to the state. Escheated property can include ... Read Full Answer >>
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center