FOOLISH FOUR PORTFOLIO

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Why Stocks Rise,
Part 2
Why 3M rose

by Ann Coleman (TMF AnnC@aol.com)

Reston, VA (January 26, 1999) -- Ooops. Yesterday I said that today we would talk about how 3M (NYSE: MMM) went up $5 on earnings news. I spoke too soon. The intraday trading in the stock peaked at $77 7/16, but the price dropped back, and the last price reported, long after the market's close, was $75 1/8 -- only $3 15/16 above the previous day's close.

3M is a good example not just of how a Foolish Four stock can turn around, but of how perceptions about earnings can influence the short-term price movements of a stock.

First, though, let me clear up a few misconceptions about stock pricing that show up from time to time in my mailbox. I think they are quite common misperceptions -- in fact, I seem to remember holding them at one time myself. The first is that people buy stock because they think the price will go up. Huh? How can that be a misperception? OF COURSE that's why people buy stock!

Well, yes, and that is the way many people think about stock prices. The idea is to buy the stock so that you can sell it when it goes up. But why does it go up? Some people think it goes up because of demand. Yes, that too is true. When more people are trying to buy a stock than want to sell it at the current price, the price goes up. But why does demand go up? You see where I am going. It all comes back to earnings, or to be precise, the market's expectation of future earnings. Unless the market thinks that earnings will grow (or, in the case of Stock.com, will materialize at some point), then there is no demand and prices will not go up.

The second misconception is that someone "sets" stock prices. It just doesn't work that way. Our stock markets are auctions. Picture movie scenes of people frantically waving pieces of paper and shouting out numbers on the floor of the New York Stock Exchange. That really is the way prices are "set." The price that is reported for a stock is nothing more than the last price at which someone was willing to buy and someone else was willing to sell. The function of a stock exchange is to bring the buyers and sellers together, usually through a broker. It's a bit more complicated than that, of course. (Isn't it always?) I will get into this in more detail in some future column. The important point is that prices are set more like in an auction than in a store. No one controls them.

Back to 3M. About two months ago 3M was selling in the low $80s and tracking along with the Dow. In early December the price started dropping due to reports about possible earnings shortfalls. Then on Dec. 16 the company announced that it expected lower earnings. Analysts immediately revised estimates to $0.80 per share, 10% below what the company earned in the 4th quarter of last year, exactly in line with company predictions.

The price of 3M's stock dropped about 10% during early- to mid-December, then it again began to track the Dow from that lower level. Yesterday morning, before the market opened, the company announced earnings of $.86 per share, 6 cents over estimates! Wow. They beat estimates! The stock shot up $6.00 then fell back a bit to close almost $4.00 higher than the previous day, adding about $1.6 billion to the company's total price tag (if you were in the market for a nice tape company).

This is all quite rational, actually. The earnings shortfall had been factored into the price for weeks, so the fact that it wasn't as bad as expected was good news and the price adjusted immediately. Today the price rose rather nicely again, indicating that the market expects the company's earnings to continue to grow from this point.

The company has been having earnings problems for months, which is why it is on our Foolish Four list. When those earnings begin to grow again, the price will grow with it.

Tomorrow: What is it about earnings?

Fool on and prosper!

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Today's Stock Lists | 1998 Dow Returns

01/26/99 Close
Stock  Change   Last
--------------------
CAT  +   9/16  45.13
JPM  ---       104.25
MMM  +   3/4   76.00
IP   +   3/4   42.81
                   Day   Month    Year   History
        FOOL-4   +1.01%  -0.10%  -0.10%   1.38%
        DJIA     +1.32%   1.56%   1.56%   1.16%
        S&P 500  +1.49%   1.88%   1.88%   3.27%
        NASDAQ   +2.71%  10.98%  10.98%  12.50%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     45.13     4.75%
 12/24/98   14 3M            73.57     76.00     3.30%
 12/24/98    9 JP Morgan    105.51    104.25    -1.19%
 12/24/98   22 Int'l Paper   43.55     42.81    -1.69%


    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1083.00    $49.00
 12/24/98   14 3M          1030.00   1064.00    $34.00
 12/24/98    9 JP Morgan    949.62    938.25   -$11.37
 12/24/98   22 Int'l Paper  958.12    941.88   -$16.25


                             Cash     $28.26
                            TOTAL   $4055.39

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