Most private investors - and many professionals - assume a stock will keep rising after favorable news, sometimes for weeks. New research points to the mistake in that thinking: when they finally buy, the price has already adjusted.
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A global sportswear company signs a contract with a new supplier, expecting to reduce raw-material costs by a fifth. Industry experts describe the move as "an unexpected success," and traders react. Four weeks later, you have money to invest. Would you expect its shares to perform better over the next year than they would have if the company had stayed with its previous supplier?
If your answer was yes, you were hardly alone. Earlier this year, economists at the universities of Bonn, Cologne and Frankfurt asked a group of British adults that exact question; their findings appeared in a July paper. Some 82% thought the shares would outperform. The same view came from roughly three-quarters of surveyed private investors in the US and Germany, along with 58% of fund managers at two large German fund groups. Respondents who answered all three standard financial-literacy questions correctly were also more likely to predict that the shares would do better.
Most finance academics surveyed by the same team reached the opposite conclusion: two-thirds said the news would not affect returns.
For a large, closely followed company like the one studied, that view makes sense. The price already reflects it.
Why does good news look like a good buy?
The mistake starts with what people focus on. When the British group explained their answers, almost everyone discussed the company's prospects; just 7% referred to the share price. The researchers' point is simple: asked whether the company is good, people often respond as though they had been asked whether its stock makes a good investment.
Those are different questions, and the difference is the price.
"They often overlook the higher price of buying those shares," says Philipp Schirmer of the University of Bonn, one of the paper's authors, referring to private investors.
Four weeks after the announcement, other investors had acted on the news too, pushing the share price higher. The company's profits had grown, but that same investment now bought a smaller stake.
What happens when you count the shares?
The researchers then showed participants the price, but their expectations shifted only slightly. Another British group read the same scenario and learned that the shares had risen 14% since the announcement. Even so, 70% still expected them to perform better, compared with 82% in the first group. Many treated the higher price as evidence that the company was better.
The clear explanation made the difference: £1,000 would buy 16 shares if the company kept its old supplier, but only 14 after the good news. Among members of the public, 49% then expected the shares to perform better - the lowest figure the researchers recorded.
Some people in the group went too far in the opposite direction, expecting the shares to fall. Counting them helps compare the good news with the price; it is not, by itself, a reason to sell.
When good news makes you want to buy, run the numbers first. Suppose you have 1,100 to invest and the shares stood at 400p before the announcement. That would have bought 275 shares; at today's price of 440p, you get only 250. The 25-share difference is what the good news has already cost you. A simple rule of thumb puts that premium in perspective: if the shares still trade at the same price/earnings (P/E) ratio, a 10% price increase means investors are now expecting profits to be roughly 10% higher, permanently.
Before you buy, ask yourself two things: Is the news worth the price, and do you know something the market hasn't already priced in?
Doesn't good news keep paying for a while?
The strongest case for buying is simple: markets may take time to absorb new information. For decades, researchers found that shares continued moving in the direction of an earnings surprise for weeks afterward. If that pattern still holds, news from four weeks ago may not have run its course.
Not much, at least among large British companies. A 2024 study examined FTSE 350 firms between 2000 and 2021 and found that shares barely kept drifting after positive earnings announcements - and the effect faded quickly. During the ten trading days that followed, those stocks outperformed the market by an average of 0.68%. After 60 days, the excess return had reached only 0.71%. Nearly all of it came during the first fortnight, meaning that an investor who waited four weeks had already missed the gain.
Even a buyer who acted immediately would have kept very little of that gain: the extra returns were calculated before costs, while stamp duty alone cuts 0.5% from most UK share investments.
The evidence concerns large companies, while UK data on smaller stocks, including AIM-listed shares, remains limited. Charles Martineau's 2022 study of US shares found that by 2006 the drift had disappeared everywhere except among the very smallest firms, where it persisted longer. For a large company under close scrutiny, such as the one examined in the survey, nearly all news is reflected in the price within two weeks.
So, does a good company make a good share?
Terry Smith's Fundsmith follows a simple three-part approach: buy good companies, avoid paying too much, and then leave them alone. Most people in the survey got no further than the first step.
A strong company may still be worth buying, but yesterday's headlines are not the reason.
Once the deal became public, existing shareholders captured the initial jump. Four weeks later, that increase is already built into the price.
When good news pushes a share price higher, compare what your money can buy now with what it could have bought before the announcement. If the tip offers nothing beyond that news, the gain has already gone to someone else.
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