The Bad News on Apple’s Stock is Only Beginning

© Mandy Cheng/AFP/Getty Images
© Mandy Cheng/AFP/Getty Images

Things are going to get worse for Apple before they get better.

Apple’s stock is suffering. After officially entering correction territory, the iPhone maker’s shares fell again Tuesday and are now down about $20 from a record $135. And it’s worth noting that, because the company has the largest market value in the world, a bigger drop might bring the broader market down with it.

But a bigger decline in Apple’s  stock is just what we should expect, given extensive research into how bad news tends to get reflected. It’s a good bet that Apple’s price will fall even further as analysts gradually incorporate the bad news into their analyses and lower their target prices.

A reason for analysts’ typically slow reaction time is that forecasting is an inexact science, at best, and they never possess enough data to make more than an educated guess. If they were to react to every piece of news or rumor that is potentially significant, price targets would jump around almost daily. So they tend, instead, to be conservative, often waiting to change their forecasts.

Take the Apple Watch, for example, on whose success the company’s future in no small part rests. Yet Apple didn’t segregate Watch sales as a separate line item in its latest earnings report, so analysts can only guess how it’s really selling. Furthermore, it’s way too early to know whether the smart watch will eventually catch on with users.

Reaction time slows when news is bad because analysts don’t like to alienate company management, on whom they depend for information and access. That can be particularly true when a stock is as widely held as Apple, since analysts don’t want to upset their firms’ institutional clients who own large positions in the stock.

As a result, according to Michael Clement, an accounting professor at the University of Texas in Austin, the market tends to react more quickly to bad news than do the analysts themselves. Thus, analysts more often than not follow the market rather than lead it.

That is well-illustrated in the accompanying chart. As Apple’s stock has fallen more than $18 over the past couple of weeks, the consensus price target for the stock has barely budged. According to FactSet, the average target price over the period has fallen a total of only $1.43 — from $147.62 to $146.19.

To be sure, analysts’ tendency to play catch-up would otherwise be of little more than academic interest. But it turns out that, when analysts do get around to downgrading a company, those reductions affect the market.

A downward spiral emerges, in other words: First, the market reacts relatively quickly to unfavorable news about a company; second, that is followed by downward revisions from analysts; and third, that, in turn, leads to even further declines in the company’s stock.

One thing that this body of research doesn’t help us determine is how far Apple’s stock may drop. But one scary precedent comes from late 2012 and early 2013, the last time Apple’s stock got caught in a vicious circle of bad news and analysts’ downgrades. When it was finally over in spring 2013, Apple’s stock was 45% lower than where it was the previous September.

Written by Mark Hulbert of MarketWatch

(Source: MarketWatch)

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