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Beware Knee-Jerk Reaction Stock Moves

By Daniel B. Kline - Updated Feb 13, 2018 at 1:28PM

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Sometimes shares in a company move for superficial, often incorrect, reasons.

Sometimes when a company reports its quarterly results, investors seem to latch onto a metric (like same-store sales) or a narrative that's pushed by the company to send shares briefly moving one way or the other. Analysts and media push a piece of data or bit of spin, causing a short-term stock move that does not reflect the actual content of the earnings release.

This may happen in part because there's a rush to react when a company reports. Investors, analysts, and the press may sometimes take action based on whatever is at the top of the release, or whatever number they were hoping for.

In general, this is temporary behavior that corrects itself once people either read to the end of the release or deeper analysis gets done. Still, it's a fairly common phenomenon that I think of as the "Sears (SHLDQ) stock bump." Shares in the struggling retailer generally move higher right after earnings are released before closing the day down from that number (but still up from the previous close), then moving even further into negative territory as time passes.

An image of a computer screen showing stock prices.

Sometimes stocks rise or fall for reasons that prove to not be the whole story. Image source: Getty Images.

A look at the Sears stock bump

Sears has been struggling mightily, but its CEO, Eddie Lampert, does an excellent job of highlighting the positive in his remarks in each earnings report. That has led to shares in the company jumping after his comments get reported, before crashing back to Earth when people read the full report and see that the retailer's prospects have not improved.

Stock price Previous day close Open Intra-day high  Close 1 week later
Q1 2017 (May 25)  $7.47  $8.80  $9.90  $8.48  $7.20
Q2 2017 (Aug. 24)  $8.57  $9.06  $9.63  $8.55  $8.21
Q3 2017 (Nov. 30)  $4.21  $5.37  $5.40  $4.08  $4.42

Data source: Yahoo! Finance. Table by author.

As you can see, shares always jump from the previous day's close when the company reports before the market opens. Sometimes that bump doesn't even last the day, however, and in the long-run it generally does not survive a week, though in Q3 it took until Dec. 12 for full reality to set back in and for shares to close below their Nov. 29 pre-reporting close. They closed at $4 on Dec. 12, and have not climbed back to $4.21 on any day since.

Here's how it works

Sears isn't unique, but it's a very public example of reactionary investors latching onto the narrative that the company puts forth. In its Q3 earnings release, the retailer included a statement from its CEO that certainly made it sound like things were moving in the right direction.

In the third quarter, we continued to narrow our losses and delivered another quarter of Adjusted EBITDA improvement of at least $100 million. With the challenging retail landscape continuing to pressure sales, the improvement in Adjusted EBITDA is reflective of the success of the strategic priorities we outlined earlier this year to streamline our operations, reduce inventory and minimize operating expenses, as well as our commitment to our goal of restoring positive Adjusted EBITDA in 2018.

That sounds nice -- but in the quarter Sears actually lost $558 million. Lampert sold that as a positive, since the loss narrowed by $190 million over the same quarter a year ago. What the CEO did not point out was that overall sales shrunk enough that the loss was more or less proportionally the same.

Reactionary investors took the news as a positive. In reality, the "improvement" was closer to the judge giving you five consecutive life sentences instead of six.

It's not just Sears

While the struggling retailer tends to produce this reaction at earnings time, other stocks get surface reaction moves for other reasons. Costco (COST 1.97%) shares tend to drop whenever another company makes a major move. For example, when Amazon (AMZN 3.58%) bought Whole Foods the warehouse club's stock dipped, and the same thing happened again when the online retailer lowered prices at its new acquisition.

This happens because casual investors and surface analysts expect that at some point the so-called retail apocalypse will claim Costco. That may happen, but the key metric for the chain is members, not sales. Amazon may take some sales from the warehouse club through Whole Foods, but if that does not cause people to not renew their Costco memberships then it's not a reflection on the health on the company.

Go a little deeper

In this day of hot takes and instant reaction, shares of a company can move based on news that's not really what it seems. Sears says it's doing better, so people accept that it is; or Costco faces a perceived threat, so shareholders panic. 

Beware this type of surface reaction and dig a little deeper than the CEO's comments or stories of a sell-off. In both cases, the truth is more nuanced, and eventually the market catches up to reality.

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Stocks Mentioned

Sears Holdings Corporation Stock Quote
Sears Holdings Corporation
SHLDQ, Inc. Stock Quote, Inc.
$116.46 (3.58%) $4.02
Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
$484.37 (1.97%) $9.37

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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