Question

When Jay Smith took the job of Assistant to the President two years ago, things were going well at the Signal Cable company. The company was on an expansionary path and had branched out into the fiber optic business. Expectations and prospects were good and the economy was very strong. The threat of competition was not too serious. Due to the expectation of increased demand for fiber optic communications, the company had established two additional manufacturing facilities and significantly increased its inventory. Signal Cable had enjoyed a high profit run in recent years. However, when the financial statements were prepared for the current year, the results showed a lower net profit margin. More importantly, there was a severe drop in the company's cash balance and the price had recently fallen from $7 to $5.50 per share. Jay knew that the shareholders would be very concerned and possibly angry. He was also convinced that his boss, Joe Mathis, would have to come up with some workable answers and suggestions about how the liquidity problems could be mitigated. This concern was primarily important as the company had been hoping Statement of Income and the Balance Sheet of the last two years.

a. Why has the stock price fallen even though net income has increased?

Answer 1

Stock price may fall due to multiple reasons, including liquidity issues, economic slowdown, and increased competition. The example of Netflix shows how stock prices can fluctuate based on future expectations and company performance, illustrating the complex factors at play.

Step-by-step explanation:

The stock price of a company may fall despite an increase in net income due to several factors. Shareholders and potential investors look at a variety of indicators, not just net income, to gauge the financial health and future prospects of a company. One possible reason for a decline in stock price could be a severe drop in the company's cash balance, which signals potential liquidity issues. Additionally, if the economy slows down or the company faces increased competition, this can also negatively impact stock price. Furthermore, if there's an increase in inventory that has not been matched by sales, this could suggest overestimation of demand, thereby leading to a decreased stock price.

An example of fluctuating stock prices can be seen with Netflix, which experienced a sharp drop in stock price during the first year after a price increase but saw a significant recovery in the following years as it expanded its subscriber base and entered new markets. This demonstrates that stock prices reflect investor confidence and the anticipated ability of a company to generate profits in the future.