Quality of Earnings: Not Every Beat Is What It Looks Like.

We tend to think stock prices react to good or bad news. But they actually react to whether that news is better or worse than expected.

Think of trying two different foundations.

The first is a viral, luxury $90 bottle that beauty creators swear will give you a flawless, filter like glow. You put it on, and it looks good. Not life changing, but decent. But because you expected a magical, pore erasing miracle, you feel completely ripped off.

The second is a $9 drugstore skin tint you bought in an emergency, fully expecting it to look cakey and separate by lunchtime. It ends up giving you that exact same decent, everyday coverage but you walk away thrilled. You tell everyone you found a new holy grail.

The physical finish on your skin was identical, but one felt like a letdown and the other like a massive win because of the bar that had been set.

Stocks work exactly the same way.

Every company walks into earnings day with a bar already set for it by Wall Street. The share price reacts to whether it clears that bar or trips over it, not to the raw numbers themselves. This is why a company can announce record profits and watch its stock drop (because the market wanted even more). It's also why a struggling company can post an ugly quarter and watch its stock rise (because the market expected something worse).

Once you realize the market trades on expectations rather than reality, it changes how you look at everything. Which brings us to Nike.

This week, Nike cleared its bar. It beat what analysts expected, but only because of a very flattering filter. And once you understand that a “beat” is only ever as honest as the expectations sitting underneath it, the next question becomes obvious.