The market's great expectations
Financial professionals laugh in the Goldman Sachs booth on the floor of the New York Stock Exchange during afternoon trading in New York City.
Goldman Sachs on Thursday told the world its profits fell 11 percent. Yet the bank's stock rose on the news. It may sound odd, but it's perfectly logical on Wall Street. The markets expected Goldman to do even worse, so when the news wasn't as bad as predicted, the stock moved up.
Fine tuning market expectations is important for public companies. It's a lot like a kid who blows a test. It's better to tell mom and dad before the report card comes. If your parents are both accounting professors, they would call that giving guidance.
"If my daughter has a test that's particularly difficult, we hear about it beforehand," says James Myers.
He and his wife Linda Myers study these issues at University of Arkansas. They have two kids and are both quick to say both are good students. But if they ever hit a bump, they say it's wise to dial down their expectations before the report card arrives.
Companies can do the same thing ahead of their own report cards, the quarterly earnings reports. Providing guidance about good or bad times at the company can help keep the stock price under control when the final news comes.
Or, another example, by way of Marketplace's Paddy Hirsch and his Whiteboard:
Mark Garrison: It’s actually pretty simple, just an expectations game. Amy Hutton is a professor at Boston College’s business school.
Amy Hutton: When Goldman announces their earnings, even if they’re down from last quarter or last year, if they’re higher than the expectation built into the stock price, the stock price is gonna go up.
Bad news can be perversely good, as long as Wall Street expected worse. So it’s important for companies to fine tune those investor expectations. It’s a lot like a kid who blows a test. It’s better to tell the parents before the report card comes. If your parents are both accounting professors, they call that giving guidance.
James Myers: If my daughter has a test that’s particularly difficult, we hear about it beforehand.
James Myers and his wife Linda study these investment issues at University of Arkansas. They say their kids make good grades and rarely need to, but sometimes a warning is wise.
Linda Myers: Because our expectations are a little bit lower, then we wouldn’t be as concerned about the low grade and I think it’s a pretty good analogy of what managers might do.
University of Michigan accounting professor Greg Miller says company guidance can work the same way. Just like parents, investors don’t like surprises.
Greg Miller: If you surprise people, they get madder. And so if there’s something coming that people are gonna be unhappy about, I’d rather own up to it now and let them know because they’re gonna be mad at me either way about the bad news.
Companies try to manage Wall Street’s expectations, to make sure a bad earnings report doesn’t torpedo the stock price. In New York, I'm Mark Garrison, for Marketplace.