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Market Reaction to IBM's Earnings Announcement

Event

After the market closed on January 21, IBM announced its fourth-quarter earnings of $3.93 a share that beat analysts estimates, yet the price of the stock fell the following day, dragging with it the Dow Jones. First Call Inc., a service that tracks earnings estimates, had projected, on average, that IBM would earn $3.88 a share.

Assuming that there was no other news about IBM or the general market, consider the following quotations as explanations for the decline in price.

Quotation 1
"IBM reported fourth-quarter earnings Tuesday that were better than expected, but some analysts feared that the results were not strong enough to maintain the momentum that has seen shares of the company soar more than 30 percent in the last three months. " (NY Times, January 22, 1997)

Answer

According to financial pricing models such as the discounted cash flow, if actual cash flows end up better than expected, the price of the stock should go up. In this particular case the opposite happened. As far as I can tell, there isn’t one good reason. However, analysts quoted by the traditional news media seem to feel that they have to come up with an explanation. Well, this gets them free publicity, and they probably think that there is no such thing as bad publicity!

The first problem with the quote is "some analysts." The opinion of "some analysts" is irrelevant as I noted in the above discussion about the "market." "Some" analysts had expected much higher earnings, others probably expected much worse. However, the consensus estimate is calculated by service providers such as IBES or First Call. Hence, it might make sense to say, for instance, that these service providers did not estimate the consensus correctly. To be more precise, they underestimated IBM’s earnings.

"[R]esults were not strong enough to maintain the momentum" is another way of saying that these analysts expected higher earnings.

Quotation 2
"Several analysts indicated the stock, trading at all-time highs, had peaked and was due for a decline."

Answer
Once again the word "several" is meaningless as indicated previously.

Now consider the explanation that the stock was "due for a decline." The fact that it’s trading at "all-time highs" cannot be the reason, since if there is new good information about IBM, stock prices should be setting new highs.

It is possible that the analyst in question believes that IBM stock is over-valued for reasons that have nothing to do with the earnings announcement. Such a person does not believe in the hypothesis that stock prices reflect a "fair’ value of the underlying company, or what is referred to as the Efficient Market Hypothesis (EMH).

Alex Tajirian