Why Do Stock Prices Drop?

Why Do Stock Prices Drop?
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Why does a stock drop after good news? Do stock prices drop after earnings? Why do stocks drop when interest rates rise? These are common questions for new investors. 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. You don't always need to worry or panic if you see stock prices drop today (or any day) – sometimes the reasons aren't an indication of a problem with the company or its stock.

Earnings Reports Come Out

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. They can impact the price of a stock in several ways, according to U.S. News and World Report.

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.

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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. 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.

Sometimes, the actions of a company leader can cause people to sell a stock, and others to worry about the impact of the CEO's or founder's actions on the future value of the stock. Papa John's Pizza and Tesla stock both suffered based on comments made by their founders.

The 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.

The 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, explains online brokerage firm Desjardins. 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.