🏷️ Tagg: investing

For years, one of the most common pieces of investing advice has been remarkably simple: buy a broad market index fund and hold it for the long run.

There is a great deal of evidence supporting that advice. Index funds offer low costs, broad diversification, and a way to participate in the growth of the economy without attempting to outsmart the market. For many investors, they remain an excellent choice.

Still, there is a subtle detail that is easy to miss.

Many investors think of a fund tracking the S&P 500 as a basket containing five hundred companies of roughly equal importance. In reality, that is not how most major indexes work.

The largest companies receive the largest weights.

This means that although an index fund may hold hundreds of businesses, its performance can be influenced disproportionately by a much smaller group.

That distinction may not matter much during ordinary times. It becomes more interesting when a particular sector captures the imagination of investors.

In the current market, artificial intelligence has become one of the dominant narratives. Enormous amounts of capital have flowed toward companies seen as leaders or beneficiaries of the AI boom. Some of these firms have reached valuations that would have seemed extraordinary only a decade ago.

Whether this enthusiasm proves fully justified is a question for the future. The technology itself is undeniably impressive. The economic consequences may be equally profound.

A funny thing happened to cybersecurity company Zscaler over the past week.

The company reported earnings that beat analyst expectations. Revenue came in above forecasts. The business itself did not suddenly stop functioning. Customers did not disappear overnight. The company's products did not become obsolete.

And yet the stock promptly lost roughly a third of its value. A few days later, it changed its mind. The stock rebounded dramatically, recovering much of the decline and ending up surprisingly close to where it had started.

Looking at the chart, someone who had been away from the news might assume some major event had occurred. A scandal. A data breach. A failed acquisition. A lawsuit. Instead, much of the drama revolved around guidance.

Management's outlook for future revenue came in slightly below analyst expectations. Not catastrophically below. Not "the business is broken" below. Just below. Billions of dollars in market value evaporated anyway. Then, with relatively little new information entering the picture, billions of dollars came back.

Zscaler’s daily closing price shows the sharp post-earnings selloff and the rebound that followed.

That sequence has been stuck in my head all week.

The Strange Thing Wasn't the Drop

A stock falling after earnings is not unusual. Investors are not buying the past quarter. They are buying expectations about future quarters.