Q & A
Consider these two events that occurred on the same
day.
Event 1:
Eastman Kodak Co. announced on January 16 that operating
profits in the fourth quarter rose by 21.5 percent.
Kodak's stock price rose by more than 5 percent, to a new
high of $85.50 on the New York Stock Exchange.
Event 2:
General Electric Co. announced on January 16 that
fourth-quarter earnings rose 11% on double-digit revenue
growth at NBC, GE Capital and its appliance and
power-system divisions. Earnings reached a record $2.07
billion, or $1.26 a share, from $1.87 billion, or $1.12,
for 1995's fourth quarter. On the other hand, its stock
closed down $1.375 at $101.50 on the New York Stock
Exchange.
Question
How can you explain the fact that two companies announced
on the same day that their profits increased in the
previous quarter, yet the market reacted differently?
Assume that the stock market is rational.
Answer
Remember stock prices at any point in time reflect a
company’s expected future performance. Thus,
today’s price reflects not just current or past
profits, but future profits.
Equipped with this tool, the answer becomes more
obvious. In the case of Kodak, at the time of the
announcement investors were pleasantly surprised by the
actual past performance, as they had not anticipated such
an increase. For General Electric, on the other hand,
investors were expecting higher earnings. Thus, with
lower actual earnings it means that they had over
estimated earnings, and thus lower earnings means lower
market price.
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