The cyclical nature of stocks.
The life story of a stock
As a trader, it is immensely helpful to know the life cycle of a stock.
Each stock goes through a cycle that starts with a lull in the stock price, travels through excessive enthusiasm, and ends with a precipitated decline or a long-time correction when the stock doesn’t go anywhere and stays in a prolonged range.
A typical cycle of stock looks like this:
The stock is said to be a value stock when it is completely ignored by the market. The ignorance is mostly because of a lack of fundamental positives. The stock may remain a value stock for times ranging from a year to decades altogether. Some stocks remain in the value stock zone for life and never come up.
I speak of opportunity cost a lot on my channel, imagine being invested in a stock for decades without a return.....
If you are a momentum trader, stock in this phase will never attract you. Value stocks are mostly picked by long-term investors who do a deep dive into the company’s business to track the changes happening in the company. They are much ahead of the rest of the crowd in identifying opportunities in value stocks.
As mentioned, some value stocks tend to have a fundamental backing that is figured out by value investors. Ultimately those fundamental factors lead to a positive surprise in the earnings, which brings the stock to the radar of other opportunistic investors and traders.
As the earnings surprise comes, these investors figure out the reason behind the surprise, and based on the sustainability of higher earnings, investors choose to invest or traders decide to trade the stock.
Sometimes it’s not clear from the start how far the earnings will grow. Therefore, investors take the leap of faith based on the upside of the story, while still digging into the story to find more about the stock.
The analyst community also takes note of the earnings surprise and apprises its earnings forecast of the company, building in the new factors that are leading to better earnings.
The analysts only make incremental changes, in the beginning, being conservative and leaving a lot of room for error in forecasts.
Whatever forecasts the analysts put out become a comparison benchmark for successive quarter earnings.