By Nick Louth, MSN Money special correspondent
Many new investors are confused by the apparently illogical movements of share prices।
Why does bad news often cause a share to rise, while good news makes it fall?
Here’s a guide to cutting your way through the jungle of market psychology।
Why does bad news often cause a share to rise, while good news makes it fall?
Here’s a guide to cutting your way through the jungle of market psychology।
Here’s a mystery. The newspapers are awash with bad news about electronic controls group Invensys – and rightly so, it would seem. The company made losses of £858 million last year, it has debts of £1.6 billion, and a pension fund shortfall of £931 million.
And it gets worse: Invensys relies for most of its sales on the US, but the recent fall in that country’s currency means each dollar it earns will look smaller when turned into pounds in its accounts।
It stopped paying dividends some time ago, and most investors expect it to be broken up and sold. The average analyst rating on the company is, understandably enough, “sell”.
Yet if you had bought Invensys shares at 10p on April’s Fool’s day, you could have more than doubled your money in ten weeks। By June 17th the shares had risen to 23p.
A sure-fire winner?
Now consider this second conundrum. On Monday computing group Autonomy announced the launch of fiendishly clever software which instantly scans all the e-mails, instant messages and telephone calls made within an organisation to check whether they comply with standards for corporate accountability laid out under various pieces of legislation both here and abroad.
So what? Well, compliance is a huge bureaucratic cost to large companies, particularly in financial services and so far has been laboriously tackled almost by hand। Yet, Autonomy’s entry into this potentially multi-billion dollar market went down like a damp squib. You might have expected a surge in its share price but it fell 10p on the day to 315p, and for the past week has lost three per cent.
What is going on?
Look to the future
Share prices are all about the constant comparison of expectations and reality. For every share traded in any market there are a series of assumptions on profits, dividend and sales which underlie the price that professional investors are willing to pay.
In the case of Invensys, the market has spent three years cutting its estimates for what the company is worth, but now some feel it has gone too far, and many feel the firm is unlikely to end up being worth nothing at all.
A research note from broker Merrill Lynch put its finger on the button early this month। It read: “The bad news is probably now all on the table and, more importantly, in the share price. Although there are significant risks, we believe the risk/reward is attractive.”
Buy on the rumour, sell on the fact
For Autonomy, the news of its entry into the compliance market had been quietly leaking out for weeks. Certainly, the shares had risen by 45 per cent from 155p to over 225p since the middle of May on rumours that a major new product launch was planned.
By the time it was confirmed on Monday, the upward price movement had taken place, and some of those who had bought early had made a healthy profit and sold, hence the lower price in the last week।
This is a well known trading process, called “Buy on the rumour, sell on the fact”. It drives a great many short-term market movements.
Sell on the rumour, buy on the fact
The reverse “Sell on the rumour, buy on the fact” works just as well, except it is used where bad news rather than good is expected. That is often why a company can come out with absolutely terrible results, yet the share price rises on the day.
Almost always, the nimblest of the professional investors have been selling for weeks (or ‘going short’, which is the process of selling something you don’t own in order to buy it back again more cheaply later) in anticipation of bad news, and then buying back in when it is incorporated into the price.
It is this process of digesting news and building it ‘into the price’ which underlies the short-term movement of stock market prices. That is why brokers are always comparing prices and expected earnings for various companies, and have distilled them into a price earnings ratio (P/E) which is the standard yardstick for comparing one share to another.
Its function is just like those ‘price per 100g’ comparisons we see on supermarket shelves which tell us whether the large £3 jar of coffee is in fact cheaper than the small £1.25 one.
Each sector in the market, whether it be banks or telecom firms has an average P/E ratio, just like we know roughly what we should pay for a 100g jar of coffee. If a member company of that sector gets out of line with the average there is either a special reason which merits further investigation, or it is out of line in which case a trading opportunity has arisen.
Every day that market examines profit warnings, better-than expected results and every other kind of corporate news. These get built into the earnings side of the P/E ratio, and the price adjusts accordingly. Above all, it is the future that matters. Once a fact is incorporated into a share price it becomes history, and you are unlikely to be able to make money from it.
No comments:
Post a Comment