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My six-year-old (!) son asked me this question and I didn't have an answer, so I told him I'd get back to him. He asked why people don't buy a large number of shares of a company before the holiday season, when they might be relatively low, and sell them after the holiday season, when all of their sales should increase the stock price.

Obviously the market anticipates the increase in sales during December and accounts for this when determining stock prices, but that explanation feels a bit hand-wavy. What really happens behind the scenes to adjust for systemic and well-known patterns in sales?

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    Why would share prices be low when everyone is buying them and high when everyone is selling them? – user253751 Jun 29 '16 at 22:21
  • Doesn't buying a lot when the price is low and selling a lot quickly once your mass buying raises the stock price count as "pump and dump"? – Daniel Jun 30 '16 at 6:29
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    @Dopapp: no, that counts as "burning money". Pump and Dump involves manipulating the stock price by getting people to buy it via email and phone spam, so generating much more artificial demand than you ever could just by the legitimate price raises caused by your own buying, and most importantly making that artificial demand last while you're already selling. Otherwise prices would plummet long before you're done selling. It also really only works on small-cap penny stocks. – Michael Borgwardt Jun 30 '16 at 7:48
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    What your six year old doesn't know is he has more common sense than most of the computer algorithms that are making 90%+ of the trades these days. They trade on how many times a company name goes through a news feed and stupid crap like that. Since he is a sophisticated 6 year old sit him down and explain how big banks use technology advantages and big money to fix the market. Tell him that if he wants to make big money he has to figure out how to rig the system or program these computers. In the background play Wall Street. 6 year olds need the hard facts :) – blankip Jul 1 '16 at 19:25
  • Your six year old has an impressive grasp of the stock market. I see that I need to do some remedial finance instruction with my seven year olds this evening. – S. Kolassa - Reinstate Monica Jul 4 '16 at 14:59
74

"Systemic and well know patterns in sales" are priced in to the security. Typically companies with very cyclical earnings like this will issue guidance of earnings per share within a range. These expected earnings are priced in before the earnings are actually booked. If a company meets these expectations the stock will likely stay relatively flat. If the company misses this expectation, the stock, generally, will get slammed.

This kind of Wall Street behavior typically mystifies media outlets when a company's stock declines after reporting a record high level of whatever metric. The record high is irrelevant if it misses the expectation.

There is no crystal ball but if something is both well known and expected it's already been "priced in." If the well known expected event doesn't occur, maybe it's a new normal.

  • 20
    So it turns out that teenager's Facebook post with "Shoot for the moon, if you miss you'll be among the stars" turns out to not be good advice for economic forecasting. Or, if you think about it, space travel either. – corsiKa Jun 30 '16 at 15:45
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    @corsiKa, lol, yes. Not very good space travel advice. – quid Jun 30 '16 at 16:21
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    I think what's even harder for people to understand is that even if Apple hits it's estimate, the stock price could drop for the simple reason that as they keep gaining market share, it's becomes increasingly less likely they can sustain the growth in market share. – JimmyJames Jun 30 '16 at 16:57
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    "The record high" can also signify fear that the high won't be beat next year... "One Trick Ponies" (iPhone being the one trick) lead to speculation that Apple can't do it again next year. I doubt that this is unique to Apple, but what the company just did (Record this) is part of a stocks price: What the buyers/sellers expect to happen - rationally or irrationally - is another part. – WernerCD Jul 1 '16 at 13:26
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    @coriKa : Neither is it good advice for Hearts. – TOOGAM Jul 2 '16 at 23:46
15

The expected holiday sales are "known" or actually guessed at beforehand, and stock prices move in line with these expectations before the holiday.

If the actual post holiday sales are more or less in line with the "guess," little stock price movement takes place. It's when the actual sales differ (materially) from the "guessed" sales that prices move up or down in the appropriate direction.

What happens is that the market "anticipates" or "guesses" first and "reacts" later, if necessary.

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    Or in ELI6 terms: Everyone knows the stock price will go up during the holidays, so they buy it before the holidays, which makes the stock price go up before the holidays, so people start buying them even earlier and earlier until the price is consistently high for the whole year. – user253751 Jul 4 '16 at 1:17
  • @immibis: You have a point. What used to be the "January effect" (prices of small, illiquid stocks go up in January after December tax selling) now starts to take place earlier and earlier in December. – Tom Au Jul 4 '16 at 1:31
  • @immibis It seems to also follow that if a company makes an announcement in March that sounds to investors like the kind of development that would lead to better-than-average holiday sales, the investors buy shares and the stock rises right then — in March just after the announcement — in anticipation of the holiday season sales, and knowing full well that if they were to wait to buy until the fall/winter, the stock price will have already risen and they'll have missed the boat. – Slipp D. Thompson Jul 10 '16 at 1:11
  • @SlippD.Thompson: That's theoretically true. But most investors are short-termers for whom six months is a long time. Your comment would be more applicable if you said, "in September, JUST before the start of holiday sales..." By the holiday season, most people will have forgotten what the company said in March, but not in September. – Tom Au Jul 10 '16 at 1:22
  • @TomAu Okay, I guess that makes sense as a norm throughout the market. I was basing my example off of the industries I know: computers & video games. It's not unusual for an announcement in March by Apple or Nintendo to lay out expectations for 6 months later, and to an extent the next few years. Oh, and I was also implying that the announcement would be regarding a product with a release date scheduled to be just prior to the holiday season. I should've been more explicit. – Slipp D. Thompson Jul 10 '16 at 1:25
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I think the question can be answered by realizing that whoever is buying the stock is buying it from someone who can do the same mathematics.

Ask your son to imagine that everyone planned to buy the stock exactly one week before Christmas. Would the price still be cheap? The problem is that if everyone knows the price will go up, the people who own it already won't want to sell. If you're buying something from someone who doesn't really want to sell it, you have to pay more to get it. So the price goes up a week before Christmas, rather than after Christmas.

But of course everyone else can figure this out too. So they are going to buy 2 weeks before, but that means the price goes up 2 weeks before rather than 1 week. You play this game over and over, and eventually the expected increased Christmas sales are "priced in". But of course there is a chance people are setting the price based on a mistaken belief.

So the winner isn't the person who buys just before the others, but rather the one who can more accurately predict what the sales will be (this is why insider trading is so tempting even if it's illegal). The price you see right now represents what people anticipate the price will be in the future, what dividends are expected in the future, how much risk people think there is, and how that compares with other available investments.

7

If you look at S&P 500's closing price for the first trading day on December and January for the last 20 years, you will see that for 10 of these years, stocks did better overall and for 10 others they did worse. Thus you can see that the price of stocks do no necessarily increase.

You can play around with the data here

6

That's a pretty good question for a six-year-old!

In addition to the good answers which point out that expectations are priced in, let's deny the premises of the question:

Sales do not increase the value of a company; a company could be, for example, losing money on every sale. Share prices are (at least in theory) correlated with profits.

So let's suppose that company X is unprofitable 320 days a year and is relying upon sales in late November and December to be in the black for the year. (Hence "black Friday".) Carefully examine the supposition of this scenario: we have a company that is so unprofitable that it must gamble everything on successfully convincing bargain hunting consumers in a weak economy to buy stuff they don't actually need from them and not a competitor. Why would this inspire investor confidence? There are plenty of companies that fail to meet their sales targets at Christmas, for plenty of reasons.

  • There are plenty of companies out there who make a majority of their yearly profit from the holiday season, and yet are not gamblers in a weak economy. Game console companies are a perfectly good example— while they sell systems and games year-round, their new release cycles are often planned around Black Friday, and those holiday sales will make or break their next upcoming year. – Slipp D. Thompson Jul 10 '16 at 1:15
5

Your explanation is nearly perfect and not "hand wavy" at all. Stock prices reflect the collective wisdom of all participating investors. Investors value stocks based on how much value they expect the stock to produce now and in the future. So, the stability of the stock prices is a reflection of the accuracy of the investors predictions.

Investor naivity can be seen as a sequence of increasingly sophisticated stock pricing strategies:

  1. A company is worth whatever its assets are worth. e.g. if the company owns 150$ of inventory and 50$ cash, but owes 100$ in debt, it is worth 100$
  2. A company is worth #1 above, plus the money it is about to make. e.g. during the holiday season it will make 100$, so it is worth 200$ total.
  3. A company is worth #2 above, but future money is discounted for uncertainty. e.g. I am only 90% sure it will make 100$ this season, so it is only worth 190$
  4. A company is worth #3 above, but future money is discounted for the time value of money. e.g. I would rather have 90$ today, then 90$ after the season, so the company is only worth 189$.
  5. etc...

If investors were able to predict the future perfectly, then all stock prices would rise at the same constant rate. In theory, if a particular investor is able to "beat the market", it is because they are better at predicting the future profits of companies (or they are lucky, or they are better at predicting the irrational behavior of other investors......)

  • " all stock prices would rise " ...? I suspect inflation itself would probably go away too. – Sam Jun 30 '16 at 20:48
  • @Sam inflation is a function of the rate at which the government prints money. there are several reasons it will never go away. e.g. 1. it inflates income tax revenue 2. it erodes real wages 3. it provides direct revenue in the form of newly printed money, etc..... – james turner Jul 6 '16 at 18:41
  • @Sam even if inflation were set to zero, stocks would still go up in value over time due strictly to the time value of money. commodities like gold would stay flat because they are valued mostly by #1 above. but assets like stocks would go up due to the profits they earn as per #2 above. in fact, most companies have a price-to-book ratio well above 1, meaning they are "worth" a lot more than the value of their physical property (e.g. buildings, inventory, etc.) – james turner Jul 6 '16 at 19:04
2

I used to be in research department for big financial data company.

Tell your son that there are three factors:

  • net sales vs. expectations
  • consumer sentiment
  • product sell-off

Most people think that net sales vs. expectations is the only factor. It might not even be the biggest. It is simply how much money did company make. Note that this is not how many units they sold. For most companies they will have adjustable pricing and incentives in their sector. For example let's talk about a new company selling Superman Kid's Bikes (with a cape the flips out when you hit a certain speed). The company has it in Walmart at one price, Target at another, Toys R' Us even cheaper, Amazon (making more profit there), and other stores. They are doing "OK" come Dec. 1 but holiday season being half way over they slash price from $100 to $80 because they have tons of inventory. What are looking at her is how much money did they make. Note that marketing, advertising, legal (setting up contracts) are a bit fixed.

In my opinion consumer sentiment is the #1 thing for a company that sells a product. Incredible consumer sentiment is like millions of dollars in free advertising. So let's say Dec. 15th comes and the reviews on the Superman Bike are through the roof. Every loves it, no major defects. Company can't even supply the retailers now because after slashing the price it became a great buy. A common investor might be pissed that some dummy at the company slashed the prices so they could have had a much better profit margin, but at the same time it wouldn't have led to an onslaught of sales and consumer sentiment.

And the last area is product sell-off. This doesn't apply to all product but most. Some products will only have a technology shelf life, some will actually go bad or out of fashion, and even selling Superman bikes you want to get those to the store because the product is so big. So ignoring making a profit can a company sell off inventory at or around cost. If they can't, even if they made a profit, their risk factor goes up.

So let's get back to Superman Bikes. This is the only product company ABC has. They had expected holiday sales at 100 million and profits at 40 million. They ended up at 120 million and 44 million.

Let's say their stock was $20 before any information was gathered by the public (remember for most companies info is gathered daily now so this is rather simplistic). So you might expect that the stock would rise to maybe $24 - to which if you were an investor is a great profit.

However this company has a cult consumer following who are waiting for the Captain America Bike (shoots discs) and the Hulk Bike (turns green when you go fast). Let's say consumer sentiment and projections base off that put next holiday sales at $250 million. So maybe the company is worth $40 a share now. But consumer sentiment is funny because not only does it effect future projections but it also effects perceived present value of company - which may have the stock trading at $60 a share (think earnings and companies like Google). Having a company people feel proud owning or thinking is cool is also a indicator or share worth.

I gave you a really good example of a very successful company selling Superman Bikes... There are just as many companies that have the opposite happening. Imagine missing sales goals by a few million with bad consumer feedback and all of a sudden your company goes from $20 to $5 a share.

2

Excellent question for a six year old! Actually, a good question for a 20 year old!

One explanation is a bit more complicated. Your son thinks that after the Christmas season the company is worth more. For example, they might have turned $10 million of goods into $20 million of cash, which increases their assets by $10 million and is surely a good thing. However, that's not the whole picture: Before the Christmas season, we have a company with $10 million of goods and the Christmas season just ahead, while afterwards we have a company with $20 million cash and nine months of slow sales ahead.

Let's say your son gets $10 pocket money every Sunday at 11am. Five minutes to 11 he has one dollar in his pocket. Five minutes past 11 he has 11 dollars in his pocket. Is he richer now? Not really, because every minute he gets a bit closer to his pocket money, and five past eleven he is again almost a week away from the next pocket money On the other hand... on Monday, he loses his wallet with $10 inside - he is now $10 poorer. Or his neighbour unexpectedly offers him to wash his car for $10 and he does it - he is now $10 richer.

So if the company got robbed in August with all stock gone, no insurance, but time to buy new stock for the season, they lose $10 million, the company is worth $10 million less, and the share price drops. If they get robbed just before Christmas sales start, they don't make the $20 million sales, so they are $10 million poorer, but they are $20 million behind where they should be - the company is worth $20 millions less, and the share price drops twice as much. On the other hand, if there is a totally unexpected craze for a new toy going on from April to June (and then it drops down), and they make $10 million unexpectedly, they are worth $10 million more. Expected $10 million profit = no increase in share price. Unexpected $10 million profit - increase in share price.

Now the second, totally different explanation. The share price is not based on the value of the company, but on what people are willing to pay. Say it's November and I own 100 shares worth $10. If everyone knew they are worth $20 in January, I would hold on to my shares and not sell them for $10! It would be very hard to convince me to sell them for $19!

If you could predict that the shares will be worth $20 in January, then they would be worth $20 now. The shareprice will not go up or down if something good or bad happens that everyone expects. It only goes up or down if something happens unexpectedly.

  • Tying back to a comparison with a kid's allowance is good. The core idea comparing the stock market with something that the OP's son should understand is that throughout they week, the allowance is being earned [R&D occurring, inventory being built, marketing campaigns occurring, etc.), and at the end of the week, the payout actually happens. Another comparison would be, if you were considering buying a retail store in July, would you value it based on June's sales, or would you value it based on a year's worth of sales, including Decembers, to estimate future earnings? – Grade 'Eh' Bacon Jul 4 '16 at 12:45
1

While there are lots of really plausible explanations for why the market moves a certain way on a certain day, no one really knows for sure. In order to do that, you would need to understand the 'minds' of all the market players. These days many of these players are secret proprietary algorithms. I'm not quibbling with the specifics of these explanations (I have no better) just pointing out that these are just really hypotheses and if the market starts following different patterns, they will be tossed into the dust bin of 'old thinking'.

I think the best thing you can explain to your son is that the stock market is basically a gigantic highly complex poker game. The daily gyrations of the market are about individuals trying to predict where the herd is going to go next and then after that and then after that etc.

If you want to help him understand the market, I suggest two things. The first is to find or create a simple market game and play it with him. The other would be to teach him about how bonds are priced and why prices move the way they do. I know this might sound weird and most people think bonds are esoteric but there are bonds have a much simpler pricing model based on fundamental financial logic. It's much easier then to get your head around the moves of the bond markets because the part of the price based on beliefs is much more limited (i.e. will the company be able pay & where are rates going.) Once you have that understanding, you can start thinking about the different ways stocks can be valued (there are many) and what the market movements mean about how people are valuing different companies.

With regard to this specific situation, here's a different take on it from the 'priced in' explanation which isn't really different but might make more sense to your son:

Pretend for a second that at some point these stocks did move seasonally. In the late fall and winter when sales went up, the stock price increased in kind. So some smart people see this happening every year and realize that if they bought these stocks in the summer, they would get them cheap and then sell them off when they go up. More and more people are doing this and making easy money. So many people are doing it that the stock starts to rise in the Summer now. People now see that if they want to get in before everyone else, they need to buy earlier in the Spring. Now the prices start rising in the Spring. People start buying in the beginning of the year...

You can see where this is going, right? Essentially, a strategy to take advantage of well known seasonal patterns is unstable. You can't profit off of the seasonal changes unless everyone else in the market is too stupid to see that you are simply anticipating their moves and react accordingly.

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    I bet all that is true for stock markets in general, but for this specific behavior we do know pretty well why stock trade doesn't fluctuate along with the company's seasonal sales, as the other answers explain. – Moyli Jun 30 '16 at 16:28
  • We know that these types of stocks do not fluctuate seasonally from past years. That, I agree with. We don't 'know' why however. We have a theory that makes a lot of sense given the evidence we have and has been a very good predictor of outcome. What really complicates things is that the theory not only predicts the market's behavior, it also directs it. I'm going to add to my answer with some details about this specific scenario. – JimmyJames Jun 30 '16 at 16:43

protected by Chris W. Rea Dec 27 '16 at 13:53

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