Last Monday, Google released its second-quarter earnings report.
The company crushed its earnings estimates by 13%… and beat revenue estimates by 2%.
Yet the next day, Google’s stock tumbled 3%. It fell another 2% the following day.
That’s a combined 5% drop over two days for a company that—by all accounts—hit a home run.
Here’s why I’m telling you about Google…
Wall Street expected Google’s price to continue to push higher on a good report.
For instance, Deutsche Bank had raised its price target for Google from $1,250 to $1,258. (As of this writing, GOOGL is trading around $945.)
That’s not a big move… But it was still 25% higher than Google’s price at the time.
If you’re a Google investor, you’re probably wondering why this reversal of fortune happened.
Nothing can be more frustrating than doing all your homework on a company… getting the call right… yet still seeing your company’s stock price fall.
Today, I’m going to show you why the market reacts like this.
I’ll also tell you the name of a company that will announce earnings tonight… And like Google, its stock price might drop even if it reports good news.
Buy the Rumor, Sell the News
Google’s stock has risen 26% since the start of the year. It reported great second-quarter earnings. And yet its stock still dropped.
The reason for this is simple: The earnings report covers what happened in the past. But the market is forward-looking.
This idea is captured in the old Wall Street adage “Buy the rumor, sell the news.”
You see, the rumor of a great report was already out there. The market already priced that into Google’s stock.
But Google’s report had one bit of news that scared off investors… and sent the stock tumbling.
Let me explain…
Most people think of Google as a search engine. But it’s really an advertising company. Over 85% of its revenue comes from ads… primarily pay-per-click.
Google displays thousands of advertisements on its search engine. Advertisers pay Google when their ads are clicked.
This quarter, the number of people who clicked on ads generated by Google’s search engine was up 52% from the second quarter of 2016. That’s all good.
The bad news was further down in the report: Google’s per-click revenue dropped 23% over that same span. That was due to stiffer competition driving down ad prices.
If this decline continues, it will hurt Google’s future revenue stream.
This Stock Is Poised for a Beating
Google is a perfect example of buying the rumor and selling the news.
Another company is facing a similar situation.
Electric carmaker Tesla (TSLA) is up over 50% since the start of the year. It’s set to announce earnings after market close tonight.
Most of that price rise assumes the company can produce 500,000 new Model 3 cars by next year.
To meet next year’s targets, Tesla needs to produce 10,000 cars every week. Per a JPMorgan report, it’s only making about 2,000 per week.
So when you see the earnings report tonight, don’t look at the headline numbers.
It doesn’t matter how much revenue Tesla made—or how much money it lost—this past quarter.
The only news that matters is whether Tesla is on pace to deliver 500,000 Model 3s by next year.
If Tesla is on pace, the stock won’t go much higher. That is already baked into the price.
But if there is any hint that it can’t make those numbers, the stock will tumble.
The risk/reward for holding through this earnings report is similar to Google.
There’s little upside… but a lot of downside if even the slightest thing goes wrong.
I think it’s unlikely that Tesla will reach those lofty goals… But we’ll see after the market closes tonight.
Nick Rokke, CFA
Analyst, The Palm Beach Daily
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From Dave S.: Hi Nick. Just read your piece about using the 170-week moving average (MA). I like to learn about these indicators so I can keep an eye on my own investments. One question though… Are you just watching this on a market level (S&P 500) only or do you do this for individual stocks, too? I appreciate all you and your team give us to think about each day. Keep up the great writing.
Nick’s Reply: Thanks for the note, Dave. The 170-week MA works very well for the U.S. stock market. As for other markets, you should do a little research.
Most stocks trade off some type of MA, but you need to find out what it is first. For instance, Apple follows a 110-day MA closely. But some stocks don’t follow any MAs. Over the past year, Walmart hasn’t found support on any MA line. So as you can see, each stock has unique properties.
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