Why does the stock market go up and down?
Well, the stock market has been likened to a teenage girl because of its erratic moods and volatility. But that’s not really a fair thing to say about teenage girls. Their mood swings are not as bad as the stock market.
So what causes this up and down rollercoaster ride?
Short-term movements of individual stocks or the market as a whole can’t really be described with much certainty, so what happens hour by hour or day by day is hard to pinpoint.
But in the longer-term, it becomes a bit easier to understand and explain. It’s like a Monet painting. Up close, everything is an indecipherable mess. Nothing seems to make sense. But with distance and time, it all becomes much clearer.
One of the real drivers of the market occurs four times a year when companies report their quarterly earnings, helping to cause the stock market to go up and down.
Forget about investing for a second. Instead, imagine if every three months your boyfriend, girlfriend, or spouse sat you down and then proceeded to provide you with a report of everything you did over the previous three months – the flowers you bought her, the birthday you forgot, and the split-second glance at the pretty woman in the checkout line. Yes, she took notes of everything you did and then assigned you a grade. This would be brutal.
Welcome to quarterly earnings. Every three months, public companies report on how they did over the previous quarter. How much stuff they sold, what their expenses were, etc. It’s a full-blown detailed report of practically everything that happened.
And guess who is interested in reading this report? Everyone! If you are invested in the company, you want to know how the company did. There will be people who focus on a particular company or industry whose job it is to really become experts at the companies they follow. These people are called analysts. If an analyst follows Wal-Mart or the retail industry around Christmas, she doesn’t go to the shopping mall to pick up presents. Nope. She goes there to see if the parking lot is full and to count the people going into or out of stores. These analysts then come up with how much money they predict the company will make in a quarter. These are called earnings predictions. That is, they are trying to predict what the company will earn in the future.
Stock Market Fluctuation Example
For example, if an analyst says a company will make $2 billion in a quarter but the company actually earns $3 billion, that surprise could really get people interested in the stock, and you might see a lot of people buying shares. This could drive the stock up. On the other hand, if the company reports they only made $1 billion, that could scare a lot of investors and they might start selling. This could drive down the price.
You might hear that a company “missed earnings.” This just means a bunch of analysts thought they’d earn so much, but the company actually earned less. On the flipside, you could hear a company “beat earnings,” which means they did better than what investors and analysts thought they’d do.
Earnings can really move the price of a stock each quarter, causing the stock market to go up and down.
Over time, it is often how well the company does selling whatever it sells that drives the price of the stock. If the company is selling more, hiring employees, expanding to new cities and countries, and cutting expenses, these are all things that are positive for the company and could increase the company’s earnings and get investors excited.
The takeaway? Companies let investors know how they did every three months (or four times a year). These are called earnings reports. The investors look at these very closely and will often respond by buying or selling based on how the company did and by how the company says it thinks it will do going forward.
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.