Last updated January 5, 2023A troubling phenomenon that many new investors observe in the stock market is its reactivity and its propensity to move rapidly. This phenomenon wouldn’t be so troubling, of course, if the company’s earnings changed on a whim daily, but obviously, that is not the case as most companies report earnings every three months.
So why does it make sense that a company’s stock price would swing so wildly within those three months? Well, it is caused, at least partially, by the people’s tendency to put undue weight on the company’s most recent earnings report. This would seem to be warranted, as it is the most recent piece of hard information, but the significance of this is quickly deteriorated when you take into account that businesses have good years and bad years.
You could take advantage of this fact by being on the lookout for a company that runs into a fixable problem. If earnings drastically drop one quarter as a result of a one-time issue that is fixable, the market is likely to overreact to such developments and price the company’s stock price at a point lower than necessary. It is up to the analyst to determine how easily fixable the problem is and whether the stock price has fallen by too much as a result of that problem.