Why does the share price tend to fall if a company's profits decrease, yet remain positive?
It has got to do with market perceptions and expectation and the perceived future prospects of the company. Usually the expectation of a company's results are already priced into the share price, so if the results deviate from these expectations, the share price can move up or down respectfully. For example, many times a company's share price may be beaten down for increasing profits by 20% above the previous year when the expectation was that it would increase profits by 30%. Other times a company's share price may rise sharply for making a 20% loss when the expectation was that it would make a 30% loss. Then there is also a company's prospects for future growth and performance. A company may be heading into trouble, so even though they made a $100M profit this year, the outlook for the company may be bleak. This could cause the share price to drop accordingly. Conversely, a company may have made a loss of $100M but its is turning a corner after reducing costs and restructuring. This can be seen as a positive for the future causing the share price to rise. Also, a company making $100M in profits would not put that all into the bank. It may pay dividends with some, it may put some more towards growing the business, and it might keep some cash available in case cash-flows fluctuate during the year. The company's value (which should be reflected in the share price) is not how much money it has in the bank, but something along the lines of 'how much money will it make between now and the end of times' (adjusted for time value of money and risk). So when you purchase a share of a company that has, say, little money in the bank, but expects to make 1M$ profit this year, 2M$ for the following 3 years, and say, nothing after, you are going to pay your fraction of 7M$ (minus some discount because of the risk involved). If now they announce that their profits were only 750k$, then people may think that the 2M$ are more likely to be 1.5M$, so the company's value would go to ~ 5M$. And with that, the market may perceive the company as more risky, because its profits deviated from what was expected, which in turn may reduce the company's value even further. You are omitting how the company made 120 million in the previous year and may be facing a shrinking market and thus have poor future prospects. If the company is shrinking, what will the shares be worth down the road. Remember companies like AOL or Blackberry? There was a time they had big profits before things changed which is the part you aren't considering here. If the company has lost something big on its earnings, e.g. the oil wells it owned have run out of reserves or the patents on its key drugs have expired, then there could be the perception that the company won't be able to compete in the future to continue to deliver earnings. Some companies may well end up going broke as one could look at GM for a company that used to be one of the largest car companies in the world and yet it ended up going broke. Aside from the market implications Victor and JB King mention, another possible reason is the dividends they pay. Usually, the dividends a company pays are dependent on the profit the company made. if a company makes less profit, the dividends turn out smaller. This might incite unrest among the shareholders, because this means that they get paid less dividends, which makes that share more likely to be sold, and thus for the price to fall. "Let's say you see a café. You're looking to buy a café so you walk into one and ask the manager how much profit he makes in a year. He says $N and you walk out and think to yourself, ""I'd be willing to pay $500,000 for this café."" You arrange to meet again to discuss purchasing the business (and he's looking for someone to purchase it).  You go into the store again the following day and the manager says, ""Sorry, I told you we make $N. I've checked the numbers and it's actually only $0.8N (20% lower than what you thought)."" Are you still willing to buy the café for $500,000 as well? No, of course you're not.  I think that this is a sufficient analogy to public companies." "In a rational market, the market caps (total value of all shares of the company) should be determined by the expected future profits of the company, plus the book value (that is the value of all assets that the company holds). The share price is then calculated as market caps divided by number of shares - a company worth a billion dollar could have a million shares at $1000 each or a billion shares at $1 each or anything in between.  When profits drop, every investor has to re-think what the expected future profits of the company are. If all the investors say ""I thought this company would make a billion profit in the next ten years, but based on the drop in profits I changed my mind and I think they will only make 500 million"", then the share price drops. On the other hand, if profits dropped because of some predictable event, then that drop was already priced into the share price. If the profits dropped less than expected, the share price might even go up.  You can see the opposite effect: Share price might be very high because everyone expects huge growth in profits over the next ten years. If profits grow less than expected, the share price will drop. Share price depends on predicted future profits, not on profits today." Let's use an example: You buy 10 machines for 100k, and those machines produce products sold for a total of 10k/year in profit (ignoring labor/electricity/sales costs etc). If the typical investor requires a rate of return of 10% on this business, your company would be worth 100k.  In investing terms, you would have a PE ratio of 10.  The immediately-required return will be lower if substantially greater returns are expected in the future (expected growth), and the immediately required return will be higher if your business is expected to shrink. If at the end of the year you take your 10k and purchase another machine, your valuation will rise to 110k, because you can now produce 11k in earnings per year.  If your business has issued 10,000 shares, your share price will rise from $10 to $11.  Note that you did not just put cash in the bank, and that you now have a higher share price. At the end of year 2, with 11 machines, lets imagine that customer demand has fallen and you are forced to cut prices.  You somehow produce only 10k in profit, instead of the anticipated 11k.  Investors believe this 10k in annual profit will continue into the forseable future.  The investor who requires 10% return would then only value your company at 100k, and your share price would fall back from $11 to $10.  If your earnings had fallen even further to 9k, they might value you at 90k (9k/0.1=$90k).  You still have the same machines, but the market has changed in a way that make those machines less valuable. If you've gone from earning 10k in year one with 10 machines to 9k in year two with 11 machines, an investor might assume you'll make even less in year three, potentially only 8k, so the value of your company might even fall to 80k or lower.  Once it is assumed that your earnings will continue to shrink, an investor might value your business based on a higher required rate of return (e.g. maybe 20% instead of 10%), which would cause your share price to fall even further.
"There are a few reason why the stock price decreases after a dividend is paid:  What's the point of paying a dividend if the stock price automatically decreases? Don't the shareholders just break even? Companies have to do something with their profits. They beholden to their shareholders to make them money either by increasing the share value or paying dividends. So they have the choice between reinvesting their profits into the company to grow the business or just handing the profits directly to the owners of the business (the shareholders). Some companies are as big as they want to be and investing their profits into more capital offers them diminishing returns. These companies are more likely to pay dividends to their shareholders. I assume the price of the stock ""naturally"" increases over the year to reflect the amount of the dividend payment. This is kind of a vague question but then doesn't it make it difficult to evaluate the fluctuations in stock price (in the way that you would a company that doesn't pay a dividend)? It depends on the company. The price may recover the dividend drop... could take a few days to a week. And that dependings on the company's performance and the overall market performance.  With respect to options, I assume nothing special happens? So say I bought $9 call options yesterday that were in the money, all of a sudden they're just not? Is this typically priced into the option price? Is there anything else I need to know about buying options in companies that pay dividends? What if I had an in-the-money option, and all of a sudden out of nowhere a company decides to pay a dividend for the first time. Am I just screwed? One key is that dividends are announced in advance (typically at least, if not always; not sure if it's required by law but I wouldn't be surprised). This is one reason people will sometimes exercise a call option early, because they want to get the actual stock in order to earn the dividend. For ""out of the ordinary"" large cash dividends (over 10% is the guideline), stock splits, or other situations an option can be adjusted: http://www.888options.com/help/faq/splits.jsp#3 If you have an options account, they probably sent you a ""Characteristics and Risks of Standardized Options"" booklet. It has a section discussing this topic and the details of what kinds of situations trigger an adjustment. A regular pre-announced <10% dividend does not, while a special large dividend would, is what I roughly get from it. That ""Characteristics and Risks of Standardized Options"" is worth reading by the way; it's long and complicated, but well, options are complicated. Finally, do all companies reduce their stock price when they pay a dividend? Are they required to? I'm just shocked I've never heard of this before. The company doesn't directly control the stock price, but I do believe this is automatic. I think the market does this automatically because if they didn't, there would be enough people trying to do dividend capture arbitrage that it would ultimately drive down the price." Remember that shares represent votes at the shareholders' meeting. If share price drops too far below the value of that percentage of the company, the company gets bought out and taken over. This tends to set a minimum share price derived from the company's current value. The share price may rise above that baseline if people expect it to be worth more in the future, or drop s bit below if people expect awful news. That's why investment is called speculation. If the price asked is too high to be justified by current guesses, nobody buys. That sets the upper limit at any given time. Since some of this is guesswork, the market is not completely rational. Prices can drop after good news if they'd been inflated by the expectation of better news, for example. In general, businesses which don't crash tend to grow.  Hence the market as a whole generally trends upward if viewed on a long timescale. But there's a lot of noise on that curve; short term or single stocks are much harder to predict. It's a big dance. Share price will go up or down based on a number of factors, many that have nothing to do with the company operations. If a CEO fixates on quarterly returns, that will cause long-term investors to want that CEO replaced, or to sell their shares. Unless a CEO is weak and can't explain the business to shareholders he shouldn't need to focus on quarterlies. If he does then shareholders short and long will take advantage of the bump in price to exit, thus depressing the valuation. Then new money comes in after CEO is replaced. "The question mentions a trailing stop. A trailing stop is a type of stop loss order. It allows you to protect your profit on the stock, while ""keeping you in the stock"". A trailing stop is specified as a percentage of market price e.g. you might want to set a trailing stop at 5%, or 10% below the market price. A trailing stop goes up along with the market price, but if the market price drops it doesn't move down too. The idea is that it is there to ""catch"" your profit, if the market suddenly moves quickly against you. There is a nice explanation of how that works in the section titled Trailing Stops here. (The URL for the page, ""Tailing Stops"" is misleading, and a typo, I suspect.)" You are misunderstanding what makes the price of a stock go up and down. Every time you sell a share of a stock, there is someone else that buys the stock.  So it is not accurate to say that stock prices go down when large amounts of the stock are sold, and up when large amounts of the stock are bought.  Every day, the amount of shares of a stock that are bought and sold are equal to each other, because in order to sell a share of stock, someone has to buy it. Let me try to explain what actually happens to the price of a stock when you want to sell it. Let's say that a particular stock is listed on the ticker at $100 a share currently.  All this means is that the last transaction that took place was for $100; someone sold their share to a buyer for $100. Now let's say that you have a share of the stock you'd like to sell.  You are hoping to get $100 for your share.  There are 2 other people that also have a share that they want to sell.  However, there is only 1 person that wants to buy a share of stock, and he only wants to pay $99 for a share.  If none of you wants to sell lower than $100, then no shares get sold.  But if one of you agrees to sell at $99, then the sale takes place.  The ticker value of the stock is now $99 instead of $100. Now let's say that there are 3 new people that have decided they want to buy a share of the stock.  They'd like to buy at $99, but you and the other person left with a share want to sell at $100.  Either one of the sellers will come down to $99 or one of the buyers will go up to $100.  This process will continue until everyone that wants to sell a share has sold, and everyone who wants to buy a share has bought.  In general, though, when there are more people that want to sell than buy, the price goes down, and when there are more people that want to buy than sell, the price goes up. To answer your question, if your selling of the stock had caused the price to go down, it means that you would have gotten less money for your stock than if it had not gone down.  Likewise, if your buying the stock had caused it to go up, it just means that it would have cost you more to buy the stock.  It is just as likely that you would lose money doing this, rather than gain money. How so? If i sell short, then i make a profit only if the price goes down so i can buy back at a lower price. Yes, but if the price is going up then you would go long instead. Shorting a stock (or any other asset) allows you to profit when the price is going down. Going long allows you to profit when the price is going up. In the opposite cases, you lose money. In order to make a profit in either of those situations, you have to accurately assess which way the price will trade over the period of time you are dealing with. If you make the wrong judgment, then you lose money because you'll either sell for a lower price than you bought (if you went long), or have to buy back at a higher price than you sold for (if you went short). In either case, unless the trader can live with making a short-term loss and recouperating it later, one needs a good stop-loss strategy. Share prices fall when dividends are paid out because the paid dividend (cash out) actually reduces the value of the company. Usually the share price falls by the amount of the dividend payment. As said by others, buying shares of a company will not support it directly. But let's think about two example companies: Company A, which has 90 % stocks owned by supporters, and Company B, which has only 1 % of stocks owned by supporters. Both companies release bad news, for example profits have decreased. In Company B, most investors might want to sell their stock quickly and the price will plummet. In Company A, the supporters continue believing in the company and will not want to sell it. The price will drop less (usually, but it can drop even more if the sellers of Company A are very desperate to get rid of the stock). So, why is it important for the company to have a high stock price? In the short-term, it's not important. One example is that the company can release more stocks and receive more financing by doing that. Other reasons are listed here: http://www.investopedia.com/articles/basics/03/020703.asp I think it may be best to take everything you're asking line-by-line. Once you buy stocks on X day of the month, the chances of stocks never actually going above and beyond your point of value on the chart are close to none. This is not true. Companies can go out of business, or take a major hit and never recover.  Take Volkswagen for example, in 2015 due to a scandal they were involved in, their stocks went downhill. Now their stocks are starting to rise again. The investors goal is not to wait as long as necessary to make a profit on every stock purchase, but to make the largest profit possible in the shortest time possible. Sometimes this means selling a stock before it recovers (if it ever does). I think the problem with most buyers is that they desire the most gain they can possibly have. However, that is very risky. This can be true. Every investor needs to gauge the risk they're willing to take and high-gain investments are riskier.  Therefore, it's better to be winning [small/medium] amounts of money (~)100% of the time than [any] amount of money <~25%. Safer investments do tend to yield more consistent returns, but this doesn't mean that every investor should aim for low-yield investments. Again, this is driven by the investor's risk tolerance. To conclude, profitable companies' stock tends to increase over time and less aggressive investments are safer, but it is possible to lose from any stock investment. Less shares outstanding means that, holding the dividend per share constant you would have a lower total dividend expenditure.  The more likely outcome is that, if you want to return capital to shareholders through a dividend, you just pay a higher amount per share. Typically a private company is hit by demand supply issues and cost of inputs. In effect at times the cost of input may go up, it cannot raise the prices, because this will reduce demand. However certain public sectors companies, typically in Oil & Engery segements the services are offered by Public sector companies, and the price they charge is governed by Regulatory authorities. In essence the PG&E, the agreement for price to customers would be calculated as cost of inputs to PG&E, Plus Expenses Plus 11.35% Profit. Thus the regulated price itself governs that the company makes atleast 11.35% profit year on year. Does this mean that the shares are good buy?  Just to give an example, say the price was $100 at face value, So essentially by year end logically you would have made 111.35/-. Assuming the company did not pay dividend ... Now lets say you began trading this share, there would be quite a few people who would say I am ready to pay $200 and even if I get 11.35 [on 200] it still means I have got ~6% return. Someone may be ready to pay $400, it still gives ~3% ... So in short the price of the stock would keep changing depending how the market percieves the value that a company would return. If the markets are down or the sentiments are down on energy sectors, the prices would go down.  So investing in PG&E is not a sure shot way of making money. For actual returns over the years see the graph at http://www.pgecorp.com/investors/financial_reports/annual_report_proxy_statement/ar_html/2011/index.htm#CS "To perhaps better explain the ""why"" behind this rule of thumb, first think of what it means when the P/E ratio changes.  If the P/E ratio increases, then this means the stock has become more expensive (in relative terms)--for example, an increase in the price but no change in the earnings means you are now paying more for each cent of earnings than you previously were; or, a decrease in the earnings but no change in the price means you are now paying the same for less earnings. Keeping this in mind, consider what happens to the PE ratio when earnings increase (grow)-- if the price of the stock remains the same, then the stock has actually become relatively ""cheaper"", since you are now getting more earnings for the same price.  All else equal, we would not expect this to happen--instead, we would expect the price of the stock to increase as well proportionate to the earnings growth.  Therefore, a stock whose PE ratio is growing at a rate that is faster than its earnings are growing is becoming more expensive (the price paid per cent of earnings is increasing).  Similarly, a stock whose PE ratio is growing at a slower rate than its earnings is becoming cheaper (the price paid per cent of earnings is decreasing).  Finally, a stock whose P/E ratio is growing at the same rate as its earnings are growing is retaining the same relative valuation--even though the actual price of the stock may be increasing, you are paying the same amount for each cent of the underlying company's earnings." It depends to some extent on how you interpret the situation, so I think this is the general idea. Say you purchase one share at $50, and soon after, the price moves up, say, to $55. You now have an unrealized profit of $5. Now, you can either sell and realize that profit, or hold on to the position, expecting a further price appreciation. In either case, you will consider the price change from this traded price, which is $55, and not the price you actually bought at. Hence, if the price fell to $52 in the next trade, you have a loss of $3 on your previous profit of $5. This (even though your net P&L is calculated from the initial purchase price of $50), allows you to think in terms of your positions at the latest known prices. This is similar to a Markov process, in the sense that it doesn't matter which route the stock price (and your position's P&L) took to get to the current point; your decision should be based on the current/latest price level. Problem with deciding investments in a company is that you have multiple potential options, each with their projected returns, but each also has some hard-to-estimate risks. A further problem is that these opportunities arrive one-by-one, so you usually cannot compare project A vs. project B to decide which one is better. The internal rate of return is a rule-of-thumb like way to make these decisions. The company board may set an IRR target of e.g. 15%, and each executive will compare their projects against that target. They'll execute only the projects that are projected to give a good return, but some of these projects will end up failing. Thus the real average profit will not be equal to IRR. Important thing is that this target number gives ways to compare projects, and also for the board to control the investments. If the company has a good track record of being successful at projects, the board might set an IRR target of 10% and expect to get e.g. 8% return on their investment. However, if the company has a much larger risk of projects failing, they might demand a predicted IRR of 20% to account for the risk. Ultimately if the IRR target is set too high, the company will find no projects it considers profitable to invest in. In practice if this happens, the company owners are better off taking out the cash as dividends and investing it elsewhere. "First off, IANAL.  Secondly, most laws are different for humans and corporations.  But, insider trading is ""trading on knowledge that isn't publicly available."" If the trade was made after the order was made public knowledge, that would probably provide the fig leaf of legality."