A:

You've likely heard the adage, "Buy the rumor, sell the news," which is the tendency for traders to push up a stock's price on rumors or expectations and then sell once that news has been released, even if the news is positive. This phenomenon is often seen with stocks releasing earnings reports.

A stock's price is based in part on the expectations investors have for the firm's earning potential. When a company releases an earnings report, the market will react to this news by adjusting the firm's stock price accordingly. 

[Fundamental events may drive the price of a stock higher or lower, but technical analysis will show you how much higher or lower the stock is likely to go, making it an essential part of the equation. Investopedia's Technical Analysis Course will show you how to identify technical patterns, trends, signals and indicators to come up with optimal price targets, with over five hours of on-demand video, exercises and interactive content.]

If a firm issues an earnings report that does not meet Street expectations, the stock's price will likely drop. However, there are plenty of times when a company meets or even exceeds analysts' expectations and the share price falls. 

For example, let's say analysts expect XYZ Corp. to report earnings per share (EPS) of $0.75. Say the company announces EPS of $0.80, beating expectations by 6.7%, yet investors respond by selling shares. While the news was "good," perhaps investors expected more. For instance, if the firm has a history of beating estimates by 10% or more, this relatively smaller beat may be seen as a disappointment. 

Perhaps you've heard of something called the whisper number. This can refer to the collective expectations of individual investors, based on their own analyses of company fundamentals and/or feelings about a sector or stock, that is not published like analysts expectations are. Whisper numbers can be significantly different from the consensus forecast. Let's say in the example above, the whisper number for XYZ Corp. was $0.85 per share. By reporting $0.80 per share, the company fell short of what investors were expecting despite beating analysts' expectations. 

Another possible explanation for a sell-off following good news is related to noise traders. The term noise trader is generally used to describe non-professional investors, but it may also include technical analysts. Noise traders do not analyze the fundamentals of a prospective investment, but instead make trades based on news, technical analysis indicators or trends. They are often thought of as impulsive and may overreact to good or bad news. So, if XYZ Corp. begins to sell off after a positive earnings report, as described above, noise traders may jump aboard, exacerbating the down move.

While there are many possible explanations for a stock's value declining despite good news being released, the most important thing for an investor to do is remain calm and consider both the time frame for your investment and the reason you bought the stock in the first place. If you have a longer-term time horizon and the news does not go against, or perhaps even supports, your investment thesis, the sell-off may represent an opportunity to add to your long position at a lower price rather than a reason to sell. 

To learn more, check out the Stock Basics tutorial and Everything You Need to Know About Earnings.

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