Why Stocks Move
A decomposition of stock price movements that challenges the idea that "fundamentals don't matter", but rather, that fundamentals are all that matter
This is a breakdown and commentary of a good tweet I saw from Brett Caughran, a former hedge fund manager at firms like Maverick and Citadel, now running an analyst training academy. See here: https://twitter.com/FundamentEdge/status/1771239097769816091
We are in a stage of markets where it is fashionable to look at the massive moves in $NVDA (+90% YTD) and $SMCI (+242% YTD) and conclude that the market is broken and price discovery is dominated by quants, pods & retail momentum traders. And to make the argument that "fundamentals don't matter." While I have my opinions on how some of the AI-levered stocks will play out (which I won't share here), I do have very strong views on the "fundamentals don't matter" debate. I'm here to assert: fundamentals are all that matter** (**with an investment horizon longer than 3 months)…
But extend the horizon even a few months (let alone a few years) and one thing hasn't changed in markets over the last two decades, and won't change in the next two decades: fundamentals are deterministic to stock prices. The analysis I will present below is a ~3 month analysis of why stocks move. - Brett Caughran
So fundamentals still move the price, and he says there are two proxies for fundamentals.
Revisions (to consensus revenue and earnings)
Expected growth
I would add that the two are related. When revenue and earnings are revised up, expected growth also increases. This is something I observed during my brief time at a multi-manager hedge fund, where often, the next few years’ growth in a DCF is modeled to be similar to the past growth. Hence, a revision upwards that increases the current period’s growth rate models out to increases in future growth rate. The two move together.
Brett’s way of putting this is “the market in its extrapolative fervor is apt to accept as baseline [the near term expected growth] for the future growth algorithm.”
This results in a dual propulsion of the stock price:
An increased NTM earnings estimate increases the stock price if the P/E multiple stays the same.
The P/E multiple expands because of increased growth expectations.
“P/Es are a point of view on the FCF stream” (Brett Caughran) of a DCF. To explain: higher future earnings in a DCF get discounted back into a higher price estimate, making the current earnings low relative to price, hence the higher P/E. In other words, high P/E just means higher expected future growth.
The Data
Let’s see this in the data, courtesy of Brett’s analysis. He took the top 25 and bottom 25 price movers of the S&P 500 in the first quarter of 2024.
Of the top 25, all 25 saw positive EPS or revenue revisions to consensus 2024 estimates. Of the bottom 25 performers, 24/25 saw negative revisions. It averaged about 10% EPS revision upwards and 4% revenue revision upwards for the winners. For the losers, it averaged 12% EPS revision downwards and 3% revenue revision downwards.
You also saw average P/E multiple expansion of about 4 turns for the winners, and contraction of 3 turns for the losers.
Post revision, the winners on average were expecting 20% revenue growth in 2024, and 10% in 2025 with 3% expected operating margin expansion. In contrast, the losers’ expected revenue growth fell from 7% to 3.5%.
Brett refers to the 27x P/E of the winners as arguably reasonable, given nearly 20% revenue growth this year, 10% in 2025, with 3% of OM expansion.
Finally, below is the data on the individual companies.
Conclusion
I thought this was a great data-backed explanation by Brett on what causes stocks to move, during a time when people point to massive stock moves, especially in technology companies, as irrational. Somebody commented about COIN, to which Brett shows its positive consensus EPS and revenue revision:
That said, it’s important to recognize that this still doesn’t explain why the individual names move by a certain magnitude. That requires a deeper understanding of the individual names. For example, see my Thesis for Coinbase (COIN) Investment in Q4 2023 regarding the recent big move upwards.
It’s also important to note, as Brett does, that this is an ex-post analysis. The hard part of fundamental equity investing is identifying these moves ex-ante.
The last thing I’ll note is this comment:
Multi-managers have strict risk limits, forcing them to sell quickly on misses. This is perhaps to the advantage of single managers, who have greater volatility limits and can buy from the forced seller, an “alpha pool as old as markets.”