Please see the below article posted by AJ Bell late yesterday (20/08/2020):
Forecast-beating results, game-changing contract wins and takeovers are just some of the catalysts that shift a stock.
So you have opened a share dealing account, familiarised yourself with the mechanics of buying a share and purchased a few companies for your portfolio. The next step on the novice investor’s journey is to learn about the numerous factors that drive a share price higher, or lower.
From a top down level, these factors include macro-economic events and data points such as gross domestic product (GDP) readings or interest rate movements, which can impact how shares as an asset class are valued relative to bonds and cash, as well as general investor sentiment towards a particular sector.
However, the key determinant of a share price is how well the company in question is performing; when a business is doing well investors want to own it, so demand pushes the share price higher, and vice versa.
Why shares fall on good results
You might notice on occasion a share price will fall after an excellent set of numbers are published. Typically, this happens when results are published after a bullish update, as the market will already have factored in strong performance.
THE POWER OF CATALYSTS
Investors need a reason to buy a share and some of the strongest catalysts to influence trading are announcements by companies to the stock market. These can be contract wins or directors buying or selling shares, though the most obvious catalysts are the publication of half-year (interim) and full-year results.
As a first-time investor, you need to understand that markets are inherently forward looking and financial figures are historic. Their ability to move a share price is determined by the outlook statement and whether the numbers are ahead of or behind market expectations.
Many companies update on trading in between their published results and analysts often respond by upgrading or downgrading their earnings forecasts.
Stockbrokers compile in-depth financial forecasts for companies which they issue to clients; these are then aggregated to arrive at consensus estimates for sales, profits and earnings per share (EPS), which the first-time investor can access via financial information providers including Bloomberg or Refinitiv, or via free-to-use websites such as Shares own site or Sharecast.com.
Forecast-beating financial results typically drive upgrades to earnings estimates, which can often combine with a ‘re-rating’ of the multiple investors are prepared to pay for a stock, providing investors with a double-whammy that sends the shares surging higher.
In contrast, profit warnings trigger downgrades and ‘de-ratings’ of a stock and its earnings multiple. Over-supply of a stock following the issue of new shares, which dilutes equity ownership, can also exert downwards pressure on a share price.
OTHER CATALYSTS TO CONSIDER
Other catalysts that move share prices include fundraisings, earnings enhancing acquisitions or balance sheet strengthening disposals. New contract wins or stake building by activist investors seeking to shake things up are additional events that can drive share price upside.
In the biotech sector, watch out for positive drug trial results, as these can drive dramatic share price appreciation, while drilling and project updates are often catalysts in the resources space.
For example, Touchstone Exploration (TXP:AIM) confirmed its significant Cascadura natural gas discovery in February and has had positive updates on the find since, sending the Trinidad oil firm’s shares gushing higher year to date.
Takeover bids typically drive a share price higher, as the acquirer usually offers a premium to the prevailing share price in order to persuade shareholders to accept cash today in return for foregoing the potential long-term upside from owning the share.
An example is motor insurer Hastings (HSTG), which recently surged higher on the back of a 250p cash bid.
The offer represented a 47.1% premium to the Hastings share price before the company alerted the market that it had received an approach.
Investing solely on the expectation of a takeover is not a sensible approach. You’ll never be able to predict with 100% accuracy which companies in your portfolio will entice a bid.
Recovery funds look for stocks that have fallen in price, yet which have the potential of climbing back or even exceeding previous levels. But an undervalued stock can remain undervalued indefinitely without the catalyst to prompt a re-rating. These might include a change of strategy or the repair of a battered balance sheet, usually accompanied or preceded by a change in senior management.
A maiden or resumed dividend can be a catalyst even if it has already been well flagged as new investors are attracted by the prospect of regular income.
WHY PROFIT WARNINGS ARE PORTFOLIO PUNISHERS
Share prices can go down as well as up and one of the main catalysts for losses is the dreaded ‘profit warning’, a broad term to describe a situation when a company is forced to downgrade its earnings guidance. It might have lost a contract, suffered higher than expected costs or experienced a difficult trading period that has caused sales growth to slow or even a sales slump, to give just a few examples.
Understanding the cause of the profit warning is paramount for deciding whether to keep hold of the shares or to get out quickly in case the shares fall further.
Sadly, lots of investors underestimate how far a share price needs to travel in order for you to get back to the level it traded before.
If a share price halved from 100p to 50p, equal to a 50% decline, then you would need the share to double, or increase by 100%, in order to get back to 100p. So try not to get too carried away when a share price starts to recover, as you may have to wait longer than you think in order to get back on track.
We often post updates and insights on the markets, but articles like this help give you a better understanding into how the markets actually work i.e. what moves a share price?
Whether you invest in direct shares or into funds/ portfolios, it is good to understand what can influence the price of a share (and ultimately your fund value).
Keep checking back for a variety of different blog content to help keep you updated, informed and to give you insights like this which help to build your knowledge of investing.
Andrew Lloyd
21/08/2020