The conventional wisdom is that when a company’s stock is falling, there is a distinct reason to stay away. But that may not be the case at all. A key principle of value investing is understanding why the market price of a stock is not always accurate. There are several reasons this may occur:
A company’s earnings report misses expectations - Corporate earnings reports are one of the most closely watched metrics for investors. Publicly traded companies are required to present investors with detailed financial statements that provide a snapshot of the quarter just completed and guidance for future quarters.
If a company delivers results that are below the expectations of the analysts that cover the company (e.g. have lower revenue and/or earnings per share than expected) shares of the company’s stock may drop lower than the company’s fundamentals suggest should be the case.
The broader market crashes or corrects - When there is a broad sell-off based on a significant event (e.g. the coronavirus pandemic) it doesn’t discriminate which stocks see their share prices fall. This can be an exceptional time to find stocks of quality companies at bargain prices.
A specific company is hit with bad news - From a product recall to a food safety issue, a company or sector can get hit with bad headlines. However, this can lead to a disproportionate response that can take a company’s shares further down than is warranted.
Normal fluctuations in the business cycle - Different sectors of the economy perform better at different times of an economic cycle. When a sector is out of favor, it can be a good time to look at finding a quality company selling at a price below its underlying value.