Why Do Stock Prices Drop?

••• Andrew Burton/Getty Images News/Getty Images

Stock prices can drop for various reasons, and sometimes the decline is caused by a combination of factors. Those can include newly released earnings reports, negative company news, and changes in implicit value, explicit value and supply and demand for the stock.

Earnings Reports

Public companies release earnings reports four times a year (quarterly). These reports contain income and profit-and-loss statements and are a testament to the company's fiscal health. When earnings reports show that profit margins are declining and/or corporate debt is on the rise, it is indicative of a decline in net income. When investors see a significant drop in income, it often induces them to sell off their shares. When this happens, it causes a drop in stock price.

Negative Corporate News

Negative corporate news ranges from product recalls to violations in accounting practices. Stock prices plunge when major negative corporate news breaks, like a corporate scandal. For example in 2000, Enron's stock was trading at $90 a share. When the Enron scandal broke one year later, its stock fell to under $1 per share. The same thing happens when companies announce they are recalling a product due to operating failures or pulling a product from the market due to possible dangers posed.

Implicit Value

Changes in the implicit value of a stock can cause it to drop dramatically in price because it is intangible. Basically, it is investors' perceived value of the stock. If investors perceive a company to be in financial trouble, whether it is or not, it decreases the implicit value of the stock. When this occurs, investors begin selling off their stock as a result of the perceived loss of value, causing the stock price per share to decline.

Explicit Value

The explicit value of a stock is the exact opposite of implicit value. The explicit value is the actual financial worth of the company, measured as assets against liabilities. If a company has more liabilities than assets, it is a sign of poor financial management or financial mismanagement on the company's part. When a company's liabilities outweigh its assets, the explicit value of the company drops. This causes the value of the stock and its price per share to fall.

Supply and Demand

The basic rules of supply and demand apply to stock prices. When investors begin a major sell-off of their shares of a company's stock, it increases the amount of available stock in the markets. When the supply of the available stock for sale is higher than investor demand to purchase the stock, it leads to a decrease in stock price. The stock price will stay low until it reaches a low enough price to induce investors to purchase the excess supply.

References

About the Author

Sue-Lynn Carty has over five years experience as both a freelance writer and editor, and her work has appeared on the websites Work.com and LoveToKnow. Carty holds a Bachelor of Arts degree in business administration, with an emphasis on financial management, from Davenport University.

Photo Credits

  • Andrew Burton/Getty Images News/Getty Images