Common Events

Every three months, publicly-traded companies are required to report earnings for the past quarter year. Investors mainly focus on the company’s revenues and net income (EPS to be more specific), but there are other figures that are just as important for certain companies. Restaurants care about “Same Store Sales Growth”, social media companies need increases in “Daily Active Users”, and manufacturing companies focus on increasing the number of contracts they receive.

Companies report their earnings either before the market opens or after the market closes, then hold a conference call to discuss these earnings and update investors on the future of their company.

Earnings season is often a volatile one. Oftentimes, a company will post better-than-expected EPS but their stock will still go down, which confuses many beginning investors. To help you navigate the confusing moves in share prices, here is a summary of what might impact a stock’s share price after it reports earnings:

If it weren’t for stock splits, some share prices would reach prices so high that investors wouldn’t be able to afford them anymore. When a stock split occurs, the share price is reduced and existing shareholders are given additional shares. For example, if you owned 10 shares in a stock trading at $100/share which announced a 2:1 stock split, you would own 20 shares in the stock after it split to $50/share. Note that reverse splits are possible, which would simply be the reverse of the case noted above.

Although the share price is cut in half, the stock isn’t any cheaper. Recall that we use the P/E Ratio to determine how expensive a share price is (See “P/E Ratio” in “Definitions”). As the number of shares outstanding has doubled (in the first case mentioned above), the EPS has been cut in half. However, the share price has also been cut in half, thus the P/E Ratio remains unchanged.

Here are the reasons why a stock split can be a positive event:
  1. If you are looking to buy the stock, you can now invest more of your money in the company. How so? In the case mentioned above, if you had $775 to invest, then you can buy only seven shares before the split which represents $700. After the split, you could purchase up to fifteen shares, which amounts to $750.
  2. If you are enrolled in a DRIP (See “DRIP” in “Definitions”), then a reduced share price implies that more of your dividends can be reinvested in the company for the same reason as the first bullet point.
When a company has extra cash on hand, it will often buy back some of its own shares. Doing so will reduce the number of shares outstanding, which immediately increases the EPS (See “Earnings Per Share” in “Definitions”). This is a common occurrence, so the stock might not jump on the announcement, but be aware that this is good news for your investment.
Oftentimes, larger companies buy smaller companies for a wide variety of reasons, but usually to increase future revenues. To explain what this means for you as a shareholder, let’s create a fictional example.

Company AAA has just acquired the company BBB. Before the announcement, AAA’s share price was $20, and BBB’s was $100. There are a couple of different types of acquisitions, so make sure you know the difference.

  1. In an “all cash” deal, BBB shareholders receive a specified dollar amount for every share they own. Unless there had been public rumors of an acquisition that drove up the stock price of BBB (let’s say from $80/share to $100/share), then AAA must offer more than the current share price of $100. If there had been public rumors, then AAA could offer anything above $80/share, which means it may be lower than the current share price of $100/share.
  2. In an “all stock” deal, BBB shareholders receive a specified amount of AAA shares for every BBB share they own. Similar to an “all cash” deal, the value of the acquisition must be greater than the value of the BBB shares before the announcement was made. In other words, the number of AAA shares received (possibly a fraction) for every BBB share owned multiplied by the current AAA share price must be greater than the BBB share price before the announcement. In this scenario, AAA would have to offer BBB shareholders at least five AAA shares for every BBB share they own.
  3. In a “cash and stock” deal, BBB shareholders receive cash and AAA shares. A possible deal would be $40 and 3.25 AAA shares for every BBB share owned. This deal is worth $105 per BBB share (40 + 3.25*20 = 105).

Here is what you can expect in regards to the share price immediately after the announcement:
  • BBB’s share price will likely skyrocket on the news to the value of the deal. For example, if AAA offers $140/share, then BBB’s share price will jump to $140.
  • AAA’s share price can go either way. Oftentimes, the share price will go down because they just spent a lot of money and/or increased their debt, which will hurt them short term. The share price might also go down because investors think that AAA overpaid for BBB. However, AAA’s share price can go up on the news as well if investors realize the potential of the combined companies. In all, the share price of AAA is really unpredictable.

After the announcement, it’s not uncommon to see some more movement in the share price of BBB. Referring to the type of acquisitions mentioned earlier, here’s why the share price of BBB may fluctuate.

  1. In this “all cash” deal, BBB shareholders are offered $120/share.
    • If BBB shares trades at $110, some investors may consider this a chance to secure a 9% return. However, if the share price is trading below the offer, it may be because investors doubt the deal will actually go through. There’s no such thing as a free lunch.
    • If BBB shares are trading at $130, some investors may think it’s time to get out before the deal goes through and they receive $120/share. Although there is nothing wrong with taking a profit, the reason BBB is trading above the offer is the belief that an even better offer will arise. Regardless, this is good news if you own shares in BBB.
  2. In this “all stock” deal, BBB shareholders are offered six AAA shares for every BBB share they own.
    • At the time of the offer, the deal was worth $120 per BBB share (6 * $20 per AAA share). However, the share price of AAA can fluctuate, which means the value of the deal will fluctuate as well. For example, if AAA goes up to $30/share, then the deal is now worth $180 per BBB share.
  3. In this “cash and stock” deal, BBB shareholders are offered four AAA shares and $30 for every BBB share they own.
    • Similar to the case above, if the share price of AAA goes up to $25/share, then the value of the deal goes from $110 per BBB share (4*20 + 30) to $130 per BBB share (4*25 + 30), thus the share price of BBB will rise to $130/share.
When two companies merge, they form one entity. It is very similar to an acquisition, but there is not a larger company that takes control of the other while maintaining the same name. Some examples include the Kraft-Heinz [KHC] and DowDuPont [DWDP]. As a shareholder, you can expect the share price to jump on the announcement. The details of the merger and what it means for your investment are very similar to those mentioned in the “Acquisition” description above.
A dividend is a payment a company pays out to shareholders. They are often cash payments, but you can elect to have those dividends reinvested in the company (for more information, see “DRIP”). Dividends are usually paid out quarterly, but there exist annual, semi-annual, monthly and even special dividends (these rare dividends are paid out by the company when they have a lot of cash on hand). There are six dividend dates to keep in mind:
  1. Declaration Date
    This is the date the company announces they will be paying a dividend. As dividends usually occur at regular intervals, this isn’t a very important date for shareholders.
  2. "Own" Date
    You must own the stock by the end of this fictional business date in order to be eligible for the dividend.
  3. Ex-dividend Date
    This is the date where the stock goes “ex-dividend”, which means new buyers are not eligible to receive the dividend. On this day, the price of the stock will drop by the dividend amount being paid out.
  4. Record Date
    Since transactions take about 2-3 days (they used to be three days, but now most of them take two days) to be settled, this is the date the company will look at their records to determine who will receive dividend payments.
  5. Payment Date
    This is the date shareholders receive their cash payments.
  6. DRIP (Dividend ReInvestment Plan) Date
    If you are enrolled in a dividend reinvestment plan, it usually takes another two weeks before the dividend reinvestment appears in your activity.
Companies often need more cash in order to finance new projects, which is why they went public in the first place. When they need even more cash, they may issue more shares in the company. This increases the number of shares outstanding, which thus immediately decreases the EPS (See “Earnings Per Share” in “Definitions”). As the EPS decreases, investors will often sell the stock which sends the share price down. The only positive spin on this announcement occurs if you believe the company can grow their net income enough to make up for the increase in outstanding shares.
This process is the opposite of a merger, but is still great news for your investment. As companies grow in size, they start to touch onto different industries, each with their own average P/E Ratio. A chemical company CCC might make fertilizer, semi-conductor equipment and plastics. While the average fertilizer company trades at 18 times EPS and plastic manufacturers trade at 20 times EPS, semi-conductor makers have more growth and so they trade at 40 times earnings. As the semi-conductor division is much smaller than the other two, the stock trades at 18 times EPS. If the company were to break up into a semi-conductor company SSS, a fertilizer company FFF and a plastics manufacturer PPP, the total share value would increase as SSS would jump up to 40 times earnings, PPP would climb to 20 times EPS and FFF would remain at 18 times EPS. In most cases, shareholders are given shares in all of the new companies.
This process is the opposite of an acquisition, and very similar to a breakup. Instead of breaking up the entire company, management may decide to spin off a single division of the company. Using the example from breakups, the company may decide it wants to get rid of only the semi-conductor division. If the company were to spin off the semi-conductor division, making it an entirely new company, the newly issued stocks would jump up to 40 times EPS and the CCC shares would remain at 18 times earnings.
There are many reasons why a company may decide to go public, but the most common one is funding. While a loan from the bank has interest and must be repaid by a certain date, equity offering are basically free cash (in exchange for voting rights).

The day of the IPO can be a crazy one, so here are a couple of details to keep in mind if you intend on buying some shares in the newly listed company.
  1. Pricing
    For the purpose of this lesson, let’s assume the IPO price is set at $150/share. Now, this does not imply you can buy shares for $150 apiece. Instead, you’ll have to buy them for whatever price they trade at the moment they start trading, which could be $200. I like to think of the IPO price as the closing price the day before the IPO. You can’t buy a stock at their closing price, you have to buy it at the opening price.
  2. Timing
    Since 9:30-11am is the busiest period of a trading day, IPOs tend to start later in the morning to spread out the chaos. Snapchat [SNAP] opened at 11:19am and Dropbox [DBX] opened just before noon.
  3. Volatility
    Most IPOs tend to skyrocket on their first day, with everyone trying to get a piece of the pie. The second day is also a big winner because everyone who missed out the day before is trying to get in on the action. However, all good things must come to an end. Most IPOs die down on the third day, so unless you believe the stock is undervalued, I suggest getting out by the end of the second day. In most cases, the more anticipated the IPO, the higher it will rise (for example, more people knew about Snapchat’s [SNAP] IPO than Blue Apron’s [APRN]).