Stocks prices and earnings
/
Source: Yahoo Finance
Oh how rare to have your expectations upset! To be genuinely surprised!
Let’s back up. I read this article from Axios where they talk about the outstanding performance of the S&P500 (up 25%), despite almost no growth in earnings.
I thought there would be an easy blog to write. I could look at the poor performance of the Vietnamese stock market and see if stocks actually track their earnings. And the result would be: No, they don’t. The theory would be that the actual increase or decrease in earnings is only a small part that drives share prices. Expectations, demand, market structure, all have a more important impact.
So I spent a long time gathering the information (I miss Bloomberg so much, or hell, even Factset - I could do so much more than I already do!). I tracked twenty of the biggest stocks in the market (by market cap), and looked at their share price return and the change in net income for 9M2019 versus 9M2018 (I chose this period because it was relatively easy to get the data).
Source: Vietecon.com calculations
It turns out that there is a trend. Stocks go up when earnings go up, and go down when earnings go down. Or to be more clear, there is a correlation between the change in net income and share price return. You can even do a simple regression and come up with an R-squared of 0.25, which is not bad.
Net income was actually up a fair amount. It rose 15% on average, and 20% if you weight by market cap. This is probably in line with about a 6-7% GDP growth rate
. Stocks did not rise as much overall, just 1% (weighted by market cap +9%). In the aggregate, net income growth doesn’t seem to explain much.
That’s why it was interesting to see that the individual stocks showed a bigger trend, as can be seen in the chart up to the left.
In some ways, this is logical. The value of a company is, theoretically, the value of all of its cash flows discounted. But there is another aspect of this - its not the actual earnings but expectations of future earnings that drive share prices. When you discount future cash flows, those flows are estimates. Let’s say something happens: a company’s product has to be recalled because of safety issues, then earnings expectations will fall. And therefore the stock price will fall. Or a company comes out with a new great product (iPhone 27.0 or some such). Then the estimate of cash flows increase, and so does the stock price.
Maybe the other way to read this is that the increase in net income was not expected. It wasn’t perfectly known by the market, and so when it happened, the stock responded positively. But that it only explains around 25% of the stock price rise (if the regression is correct, and that’s a big “if”). The rest were what I mentioned before: expectations, market structure, demand for Vietnamese stocks as an asset class, etc.