If you’ve participated in any of our webinars, you likely saw this moment coming.
The presentation wraps up. The Q&A starts. Almost immediately, someone brings up the unavoidable question:
“Why is it down?”
This could be a stock that you own or monitor, or a company that shouldn’t be declining since it appears “healthy” on paper. The dividend continues to be disbursed, and the company isn’t in bankruptcy, yet the market lowers its valuation.
A stock may decrease for numerous reasons—many investors investigate in the wrong areas, chasing after headlines, tweets, or hot takes, which typically result in anxiety instead of understanding.
Instead, you require a systematic approach to apply whenever a stock drops, be it a 5% decrease in one day or a 25% downturn over six months.
This article presents the checklist I reference to respond to “why is it down?”—and, crucially, to assess whether it’s a problem or a possibility.
Step 1: Let the Figures Speak First (but don’t stop there)
Before diving into opinions, take a look at the facts.
Begin with essential figures: revenue, profit, and the dividend. Typically, one of these three will clarify the movement or direct you toward the solution.
A stock is often in decline due to a recent result indicating:
- Revenue has slowed, declined, or failed to meet expectations
- Earnings have dropped (or the market forecasts they will)
- Margins have tightened (costs have risen faster than sales)
- Management has provided lower guidance for forthcoming periods
Make the appropriate comparisons.
Year-over-year (Q1 vs Q1 of the previous year) comparisons are generally most effective since businesses often have seasonal patterns. Ski companies don’t sell skis in July, and hardware stores don’t sell snowblowers in May.
Occasionally, management will emphasize sequential improvement (Q1 vs Q4) if the prior year’s quarter was especially strong or weak. While valuable, year-over-year should be your baseline.
Step 2: Delve Deeper into the Quarterly Earnings Narrative
Once you find what changed, next discover why.
Many investors jump to conclusions too quickly, assuming a company is struggling after seeing: “EPS down 12%.”
However, “EPS down” can convey various meanings.
Frequent scenarios causing stock downturns include:
Revenue remains stable, but EPS declines.
This is typically a margin issue. Rising input costs, wages, shipping, marketing, or discounts may have diminished profits.
Revenue is increasing, yet EPS is decreasing.
This might happen when growth incurs costs: a product launch, an expansion, or an acquisition that hasn’t started generating returns.
EPS fell due to “one-time” factors.
Charges for impairment, restructuring expenses, legal settlements, or write-downs can have a significant influence on reported earnings. Despite being potentially non-recurrent, they still hold importance, signaling change.
And an essential reminder: EPS isn’t always the most reliable metric.
For capital-intensive sectors (pipelines, utilities, telecoms) and REITs, earnings may seem weak due to depreciation and other non-cash factors. Metrics such as DCF per share, FFO per share, or AFFO per share can offer deeper insights. Using an unsuitable tool for a specific business can lead to erroneous conclusions.
Step 3: Utilize the Dividend Triangle as Your Health Assessment
When a stock is on the decline, your initial response might be to review the price chart, but instead, examine the Dividend Triangle and address three questions:
- Are revenues advancing?
- Are earnings (or the appropriate cash metric) increasing?
- Is the dividend increasing?