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Ask a Fool: If a Stock Falls After Earnings, Is It Time to Buy?

Q: If a stock misses earnings and the share price plunges, is it a good time to buy?

The short answer is that it depends why the company's quarterly report caused the share price to drop.

If something fundamentally changed with the business that could become a long-term issue, such as a slowing growth rate, intensifying competition, or declining sales, then that share price drop could be entirely justified.

One example that immediately comes to mind is Starbucks (NASDAQ: SBUX), which reported earnings just a few hours before I wrote this. The coffee chain's same-store sales growth missed expectations by a wide margin due to challenges that have been cutting into its store traffic since last year. Those factors indicate that its growth could be slower than had been anticipated. I'm not saying that Starbucks is a bad stock to own – rather, I'm saying that slowing growth could be a long-term issue, and as such needs to be taken into account when valuing the stock.

On the other hand, Facebook (NASDAQ: FB) reported an excellent quarter, but its share price dropped because CEO Mark Zuckerberg said his company will dramatically ramp up spending next year to prevent the abuse of its platform. For example, Facebook will double the number of workers dedicated to keeping fake news and hate speech off its site by the end of 2018.

Although this will cut into profitability, the impact is likely to be temporary. In other words, the company' growth story is still alive and well, even if for the time being, expenses are going to grow faster than sales. If the company keeps growing at its current rate, it will ultimately absorb those additional costs and then some.

Bottom line: It's important to distinguish between a temporary setback and a lingering change to a company's business when digesting an earnings report. Temporary setbacks are the situations that tend to produce bargains.

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Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook and Starbucks. The Motley Fool has a disclosure policy.