It’s hard to watch when your share prices are going down, and go down they do. Having an understanding of why they go down helps in ironing out the emotional roller coaster ride of stock market investing so in this blog, The 5 key reasons for declining share prices, I’m going to highlight some of the reasons they go down and and what you should do in the event of falling share prices.
Reason 1: Profit Warning
As part of being listed on the Stock Market Companies have to disclose their profit forecasts for the coming year. This gives the investor an idea of what to expect and make decisions accordingly. Invariably, as was recently the case with Halfords, these forecasts can be wrong and Freddie Fund does not like surprises and dumps the stock. When Freddie goes, they all go because no Fund Manager wants to be the only one holding the baby.
What do you do?
You can’t predict how well a company is doing. If your company issues a profit warning you have to objectively understand the reason for the warning. In the case of Halfords, most companies now are in a headwind, with inflation, rising interest rates and the fallout from covid and global supply chains etc so it doesn’t surprise me profits are being hit. If the reason for the warning isn’t a terminal issue ( like government banning gambling (and you own ladbrokes shares) ) and the reason is a short term issue ( Halfords are claiming the weather has caused the problem), I would take up the opportunity to buy more shares at a cheaper price.
Reason 2: Commodity Prices
If your company requires a certain product to make profits and the price of that product goes up, this will invariably have an impact of profit. Carnival cruise lines share prices dropped considerably on the back of rising oil prices. There are thousands of analysts trying to predict the outcome on profit in this situation.
What do you do?
Again, as with reason 1, assess whether the rising prices is a terminal, long term or short term problem. If it’s terminal or long term it may be an idea to cut your losses but if it’s only a short term issue I would consider buying more shares at the cheaper price.
Reason 3: Global economic news
Freddie Fund does not like bad news, period. From invasions, Tsunami’s, Interest rate rises and all the other ‘The world is going to end’ News stories, Freddie sells. Good news is treated with cautious optimism whereas bad news is dealt with severely. Freddie can’t afford to have any negative positions on his books. His and his firms reputation is on the line.
What do you do?
Let me make one thing clear. You cannot predict the future. These events are going to happen. The stock market is going to rise and fall as you can see from the graph but the curve is upwards. By investing in the long term timeline and buying quality companies reduces the risk of stock market losses so what do you do if some global economic news crashes your shares? NOTHING. Just ride it out and buy more shares at a knock down price.
Reason 4: Shorting stocks
Everyone is waiting, waiting for the next play. Who is doing what? Somebody sells a substantial chunk of shares 5 minutes before the end of the day. What does this mean? Do they know something bad or is it a bluff? Tracy trader has spotted this and decides to short the stock. She borrows 10,000 shares from her broker at £10 a share and sells them immediately, netting her £100,000. Now she waits. She hopes that the share price will go down and she can buy the shares back at say, £7 a share. It does. She buys 10,000 shares at £7 costing her £70,000. She then gives the shares she borrowed back to the broker. She’s made a cool £30,000. Not bad for a few hours work. If this is happening all over the world, the share price will just keep tumbling. However, the person who sold the large volume of shares in the 1st place may have just needed the money to pay off a divorce or they decide to invest in something else and there is nothing wrong with the company. The share price has dropped for no reason.
What do you do?
When traders start a shorting war game the only thing you can do is let it happen. When this happens to me, I go back to the Stockopedia stock sheet and go over the reasons why I bought the stock in the first place. If the fundamentals haven’t changed and the reasons for buying haven’t changed I say thank you and buy more shares at a cheaper price.
Reason 5: There’s a better opportunity elsewhere
Oddly enough, it could be as simple as that. If another company posts record profits, everyone sells and buys the other company’s shares. When shares are being sold the share price keeps dropping until buyers start buying. This is going on all the time. There’s nothing actually wrong with your company , it’s just that Freddie thinks that future prospects for his fund are better served investing in this other company.
What do you do?
Time is your best friend and your worst enemy depending on how you use it. The average fund manager does not have the luxury of time because they have to deliver positive results on an annual basis. Their neck is on the line so they constantly chop and change their portfolios to hit their targets. We, on the other hand have decided that we don’t need the money for a minimum of 5 years so we can sit out the turbulence and wait for the share price to rebound.
The 5 key reasons for declining share prices- Conclusion
Companies can and do run into troubled waters from time to time. Understanding what the problem is and identifying whether it’s a terminal, long-term or short term problem is key to the decisions you make when share prices a declining. Panic selling to cut your losses will not help your investing returns. This is where your temperament comes in. Peter Lynch calls it ‘The Stomach‘. Nobody has a Midas touch and turns everything to gold so you have to objectively rationalise the reason for the decline and in most cases buy more shares at a cheaper price. In my next blog I’m going to discuss 5 key reasons why share prices go up.
0 Comments