Google is earning more money, so why is its stock going down?
Alphabet (GOOG), the company that runs Google, released their 2nd-quarter earnings today. To everyone’s surprise, revenue and earnings came in above analysts’ expectations. In other words, the company earned more money last quarter than people expected. This is good news, right?! Doesn’t this mean Alphabet is doing well? If so, why is the stock price down?
If you’re going to be buying stocks, there’s one lesson you need to learn quickly!
Stock prices aren’t based on what a company has done, but instead on what it is expected to do.
Stock prices are like predictions. The value of a stock is based on future sales and future profitability. But like our friend Yogi Berra said, “It’s tough to make predictions, especially about the future.”
For a large company like Alphabet, there are many financial analysts working at investment banks and investment companies that will write reports and issue opinions on what they believe a company will earn in the next quarter, the next year, and the next two or three years. Average all of these predictions together and you get what’s called consensus, or market expectations. The value of a share of stock will (usually) adjust up or down based on these consensus expectations.
The price of Alphabet stock today, until market close – when they released their Q2 (2nd quarter) earnings, was around $975/share. The price of the stock was based on consensus expectations of Alphabet generating $25.65 billion in revenue. Well, the firm delivered news that they earned $26 billion!
If this was the only news they delivered, then GOOG would have quickly adjusted upward in price to reflect the positive news. Much of the company’s value is still based on future revenue and earnings; just think of these quarterly updates as price checkpoints, where the value of the stock can make a snap adjustment due to updated expectations.
Unfortunately for Alphabet, along with this good news, they released some bad news: their costs are going up, and they are going up faster than revenue. While revenue is growing at 20% per year, their costs are growing at 28% per year. This negative surprise was enough to outweigh the positive effects of the revenue surprise. That is why the value of Alphabet is falling, even though they are growing faster than expected.
When you buy a stock, you need to know what you are buying and why. Furthermore, you should have an opinion regarding what the stock should be worth. If you don’t know how to do that, I strongly suggest you stay away from purchasing individual stocks. I’ve seen too many people buy individual stocks at ridiculous prices because they simply didn’t understand what the stock price implied about market expectations, i.e. they bought at way too high a price.
Here’s a quick example. If GOOG was selling today for $30/share, would you buy it? Why? What if it was selling at $10,000/share?
If you said “yes” to the first and “no” to the second, but you can’t back it up with any reason other than, “well its market price is currently $950,” then you, yes you, should stay away from stocks for the time being.
– at least until you learn how to value them. 🙂
Just remember, the value of a stock is based on its future earnings. Too bad the future is so hard to predict.
Do you have a question, or would like me to cover a particular topic, feel free to leave a comment below!