Making sense of the wild stock market ride

Published in the Herald Sun, August 2010 by Karnina Barrymore

Shareholders are on the roller coaster again as share prices continue to fall despite companies reporting some hefty profit increases.

Only a couple of weeks into the latest reporting season and already there are a string of companies which have made big profits but their share prices have failed to fire.

So why do share prices go down when profits go up?

In a nutshell, it's because share markets are basically forward looking and company profits are "old news", reflecting the past year.

What shareholders and investment markets are more interested in is what's going to happen in the year ahead.

"Stock prices are based not so much on a company's current fortunes but estimates and forecasts of future earnings," Australian Stock Report head of research Geoff Saffer said yesterday.

According to fund manager Wealth Within founder Dale Gillham, many shareholders also choose the announcement of a big profit to sell out of a company. This is based on the investment theory they will be selling "at the top" of the share price.

"Taking a contrarian view to investing, the best time to sell is when the best news about a company is reported," Mr Gillham said.

"Record profits are the best news, therefore large-scale selling after this announcement is common and you find that volumes for people wanting to buy the share are also higher making it easier to sell."

During the past week several major companies have reported significant profits but their share prices have tanked.

COMMONWEALTH BANK is probably the most high profile of these companies so far this reporting season. Despite a42 per cent jump in cash earnings and a 50 per cent lift in the dividend payout to shareholders, their shares fell 3 per cent on the day.

"However, the bank sounded a very cautious outlook in light of current global market uncertainty," Mr Salter said, "as a result its shares slumped."

The dividend increase was also over-inflated because the bank had cut its payout ratio last year, during the global finance crisis.

COMPUTERSHARE also reported an 11 per cent profit rise and healthy dividend boost last week but its shares still plummeted 10 per cent on the day.

The gloss of the strong profit and increased dividend was wiped off because the company forecast up to a 10 per cent fall in earnings for the new year.

JAMES HARDIE was back into profit this year but still had its share price marked down because it had given up hope of a quick fix to the problems in the US housing market.

James Hardie shares fell 7.5 per cent on the day it announced a net profit of $US104.9 million for the quarter compared with a loss of $US77.9 million the previous year.

TELSTRA reported a profit in line with expectations but which was still down 4.7 per cent. However, its shares were hammered, plunging almost 10 per cent on the day.

"The company issued a very weak outlook, warning that FY11 sales would be flattish and core earnings would decrease. The weak outlook weighed heavily on Telstra shares with the stock hitting a new record low," Mr Saffer said.

The past year's earnings are important to the overall health of the company and related to how much dividend shareholders will be paid, but they offer little relevance to investors looking for the next big gain.

"For the most part, companies' earnings go up or down by a very rough 10 per cent most years," Mr Saffer said.

The big end of town - the wholesale and institutional investors - also play a major role in the movement or share prices.

"Institutions account for about 80 per cent of all trading on our market and, in general, they are buying or selling on future earnings," Wealth Within's Mr Gillham said.

However, institutions typically buy well before these profits are announced - based on their internal research and expectations. So when the results are published it often acts as a trigger for these big investors to sell their shares at a profit, Mr Gillham said.

This focus on the future also applies to companies that report a profit fall but their shares go up.

HUTCHINSON TELECOM, for example, saw net profit and revenue fall by about 97 per cent for the first half of 2010 and shareholders were told they won't be getting a dividend.

However, the group's positive outlook, especially for the forecast increase in new subscribers, "outshone" the bad news, with shares rocketing 14 per cent on the day.

"A company's outlook is just as important, if not more important, than looking at the headlines about a company's financial performance," Mr Saffer said. "In financial markets, the future is more important than the past."

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