What Makes a Company’s Stock Price Go Down?

In the midst of the biggest stock market drawdown since March of 2020 I had a major personal development . My son Ben was born on January 23rd which is interesting timing for the births of both my kids.  My eldest Rowan was born on March 24, 2020.  If you go back and look at the market on that day you will see that the market bottomed on March 23rd and started one of the great bull runs in 2020.  March 24, 2020 was the best day in the stock market since the 1970s.  Now 2 years later we are still dealing with the pandemic and the market is crashing again.  Let’s hope that Ben’s arrival will herald a turnaround like Rowan’s did!

Why do stocks go down though?  Well the common sense answer would be that good businesses go up in value and bad businesses go down in value.  And over the long term, that is roughly correct.  If you hold a good business for a long time, the value of your investment should go up.

Short Term vs Long Term

However, we know things are never that simple.  Even though a stock’s price over the long term will track the quality of the business, over the short term, the price can deviate wildly, and often becomes completely detached from the underlying business value. This is a good thing for us because it allows us to purchase great businesses at bargain prices, but can seem alarming when it is happening.  This is also true of all stocks, large and small.  The stock prices of some of the largest businesses in the world can become completely detached from the underlying business.  We know this to be true because we can see it plainly in hindsight.

Example

Take for example Canadian Natural Resources (CNQ). CNQ is one of the biggest and best energy companies in Canada and in the world.  In fact in my opinion it is one of the best businesses in Canada out of ALL sectors and not just energy.  Despite it’s size and quality however, CNQ’s stock price can be very volatile.  Prior to the pandemic CNQ’s stock price had peaked at $49.08 in July of 2018.  During the start of the pandemic in the spring of 2020, all stocks crashed but in particular energy companies were hit especially bad.  CNQ lost 80% of its value and you could have bought shares for as low as $9.80 on March 20, 2020.  Of course the business quality didn’t change during that time, and the stock has subsequently recovered to new highs.  It has rallied 569% since then and currently trades at $65.58.  Anybody who sold their CNQ shares near the bottom missed out on a fortune.  Thankfully I can say that we were buying CNQ stock in March of 2020.

Another story which doesn’t directly involve our clients was Amazon stock during the tech bubble and crash of 2000-2002.  By December of 1999 Amazon was a hot internet startup in the midst of the biggest boom of all time.  It’s stock price reflected this brilliance as it rose from $2 a share around the time of its IPO in May of 1997, all the way up to $113 a share in December of 1999.  Anybody who had owned shares from the IPO got very rich.  However, December 1999 was the peak for Amazon and over the next 2 years it’s stock lost 95% of it’s value and traded as low as $5.51 a share in October 2001.

If you had owned Amazon throughout this period it would have been very difficult to have bought at the IPO, made a huge fortune, and then lost nearly all of it, all within the span of just over 4 years.  How many people would have been bullish on Amazon in October 2001?  To be fair, there were some investors who were, but not many.  Of course in hindsight we know that those Amazon bulls were absolutely correct as the stock has appreciated by 39,911% (WOW!) since then. Anybody who held Amazon stock from the IPO is much much richer now than they were in December of 1999.

Did Amazon’s business change during that time?  It did change as the company grew but not nearly enough to justify the extreme movements in its price.  All of the ingredients of Amazon’s success were there for the people who took the time to study the company carefully.  And that’s why some bullish investors like Bill Miller and Nick Sleep were able to buy Amazon stock during this period and make tons of money on the juggernaut that Amazon was becoming.

So that is WHAT has happened in the past, but WHY does it happen? Why can such large and quality businesses trade so violently and deviate so much from the value the business would justify.

Why Do Quality Businesses Deviate From Their Value?

In short people’s emotions get in the way of rational trading. What was common about all of the extremes involving CNQ and Amazon prices above is that the markets were being influenced by wider events that were pushing stock prices to extreme levels. In Amazon’s case it was the tech bubble and subsequent crash which created the extreme price movements.  In CNQ’s case the pandemic caused a huge drop in demand for oil and cratered the price on world markets.  On top of that there were (and still are) calls for decarbonization of the economy and the belief that fossil fuel companies are a dying industry.  These effected the broader industries of Amazon and CNQ and made it hard to see the quality of the businesses that Amazon and CNQ represent.

A Different Way To Look at Price Drops

As I said at the start of this post, we are in the midst of another market correction right now.  Some of the companies that we own have fallen quite a bit from their all time highs. If we were foolish investors we might assume that this drop in the prices represents a real problem with the underlying business.  However we don’t think this is the case at all, and we KNOW that market prices can become detached from the quality of the underlying business.  While we do want to verify that we haven’t made a mistake whenever the price of a stock we own drops, in this case I think there are clear signs that the drops in price are not indicating a problem with the businesses themselves, but rather represent a larger macro shift in investor’s thinking now that inflation is up and interest rates might start to rise soon.  This doesn’t change the underlying quality of the businesses we own and in the long term we KNOW that owning great businesses is the key to great returns in the stock market.  In fact I am excited at the low prices that we are currently able to purchase some of these companies and I expect that they will lead to great returns in the years to come.

- Craig White, BA, LL.B., CIM®

Craig White is an Investment Advisor at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.