If you knew what would happened to stock prices even after earnings per share increase, you could probably retire early. It seems logical that a company's stock price would rise if earnings increase, as earnings are a representation of profits. While this is sometimes the case, at other times the market value, or stock price, falls, much to the chagrin of company executives. While an increase in EPS is generally a positive development, the stock price reaction can surprise even the most seasoned investors.
EPS and Volume
In some cases, stock prices rise in the days leading up to and immediately following an earnings announcement simply because more attention is being paid to the company, according to a 2008 National Bureau of Economic Research report. When a stock price rises, trading volume in that company is generally high, meaning that investors are buying or selling shares more frequently than normal. A declining stock price, on the other hand, is generally accompanied by low trading volume. Broadly speaking, individual investors -- not necessarily large institutions, such as money management firms -- tend to show increased interest in a stock when it is in the spotlight for earnings, whether the results are positive or negative, and this can lead to higher trading volume and a rising stock price.
Shareholders are also concerned with whether or not a company meets its EPS estimates. While it is encouraging to see a company earning more money, investors generally want to know if the business is performing up to a certain standard. Two sets of earnings estimates are typical -- one provided by Wall Street analysts and another offered by inside executives at the company that's reporting earnings. You can take company projections with a grain of salt, however, because company officials may be attempting to sway financial analysts toward a certain number, according to a 2012 "USA Today" article. A stock price has a tendency to decline if a company fails to meet analyst estimates for EPS, the article indicates.
If a company's EPS exceeds the results from the previous quarter or year and beats Wall Street estimates, it's not uncommon for the stock price to rise. In 2013, home-improvement retailer Home Depot topped its year-ago EPS performance and exceeded analyst estimates. In response, the stock price climbed nearly 6 percent, which was its best performance in about four years, according to a 2013 article on the Bloomberg website.
When investors have bigger concerns than the types of profits a company is reporting, they might not place that much importance on EPS even if a company's profits are rising. In the third quarter of 2011, more than half of companies in the S&P 500 index -- a weighted index of 500 large-cap, heavily traded common stocks -- surpassed EPS expectations. Nonetheless, the average stock price for these companies fell about 0.4 percent in this period as investors responded more to uncertainty about Europe's economy than they did to earnings performance, according to a 2011 CNBC article.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.