The Essence of Stock Price Volatility Series — Profits Edition: Profit Explosions and Valuation Uplifts Under Supply-Demand Imbalance

Shaanxi Coal Mining: incurred a RMB 3 billion loss in 2015 and traded below book value; posted RMB 10 billion net profit in 2017, with its P/E ratio recovering to 10–15x—its stock price tripled over two years. 3. The Resonance Formula of Valuation and Profit Stock Price = Earnings Per Share (EPS) × Price-to-Earnings Ratio (P/E) Under supply-demand imbalance: EPS: surges exponentially due to profit explosion (shifting from losses or marginal profits to high profitability); P/E: rises significantly due to greatly enhanced earnings visibility (shifting from low valuation to fair or high valuation); Ultimately achieving EPS↑↑↑ × P/E↑↑ = explosive stock price appreciation. V. Transition Between Weak and Strong Cycles: A Complete Closed Loop of Profit + Valuation Explosion 1. Bottom of the Weak Cycle: supply rationalization, inventory depletion, capacity shutdowns, industry-wide losses, and extremely low valuations (trading below book value / low P/E); 2. Start of the Strong Cycle: demand recovery, emergence of supply-demand gaps, rising prices, narrowing losses, and initial valuation recovery; 3. Mid-Phase of the Strong Cycle: simultaneous volume and price increases, cost amortization, exponential profit growth, strengthened earnings certainty, and substantial valuation uplift (the core phase of the 'Davis Double Squeeze'); 4. Late Phase of the Strong Cycle: new capacity comes online, supply-demand gaps narrow, prices peak, profit growth slows, and valuations decline. VI. Classic Cyclical Cases: Empirical Validation of Dual Profit + Valuation Squeeze 1. Coal Cycle (2012–2017) Weak Cycle (2012–2015): weak demand + overcapacity drove thermal coal prices down to RMB 370/ton, triggering industry-wide losses; China Shenhua’s P/E fell below 8x. Strong Cycle (2016–2017): policy-driven capacity reduction + demand recovery lifted coal prices to RMB 700/ton; Shenhua’s net profit surged from RMB 16 billion to RMB 45 billion (a 180% increase), and its P/E recovered to 15x—its stock price doubled over two years. Core driver: supply contraction → profit explosion → valuation recovery. 2. Lithium Cycle (2020–2022) Weak Cycle (2018–2019): depressed lithium prices led Tianqi Lithium to post losses; its share price stood at RMB 20, rendering valuation meaningless. Strong Cycle (2020–2022): explosive EV demand + supply rationalization pushed lithium prices to RMB 600,000/ton; Tianqi posted RMB 24.1 billion net profit, with its P/E rising to 25x and its share price climbing to RMB 140. Core driver: demand explosion → profit reversal → valuation uplift. VII. Summary The dual explosion of corporate profits and valuation is, at its core, an inevitable outcome of supply-demand imbalance across cyclical shifts: 1. Inelastic supply contraction: natural consolidation, policy-mandated capacity reduction, and unexpected disruptions jointly constrain supply’s ability to quickly match demand; 2. Immediate demand surge: technological transformation and macroeconomic recovery inject unexpectedly strong growth momentum; 3. Temporal mismatch amplifying the gap: persistent widening of the supply-demand gap propels firms into a phase of simultaneous volume and price expansion; 4. Non-linear profit growth: sharp price hikes + controllable costs + surging sales volumes + cost amortization collectively drive exponential EPS growth; 5. Davis Double Squeeze on valuation: high earnings growth rate + high earnings certainty push P/E from deeply discounted levels up to fair or premium valuations; Final formula: Stock Price = [(Unit Price↑↑↑ − Cost↑) × Sales Volume↑↑ − Fixed Costs] × Valuation (Uplift) From shipping to lithium, from coal to neon gas, while sector-specific cycle dynamics differ, the underlying logic remains highly consistent: inelastic supply rationalization + unexpectedly strong demand = persistently widening supply-demand gap = non-linear profit growth + Davis Double Squeeze on valuation = stock price doubling.

Why does a listed company’s stock price plummet despite rising profits?

This is an excellent and very practical question—one that confuses many retail investors: “If the company’s performance is solid, why is its stock price falling?” First, the conclusion: In the long term, stock prices fluctuate around a company’s intrinsic value; in the short term, however, stock prices are driven by market sentiment, fund flows, and valuation levels—not directly by current-period profits. I. Long-Term Perspective: Stock Prices Track Earnings Corporate operating performance serves as the ‘anchor’ for stock prices. Over a 5–10 year holding period, stock price appreciation generally aligns closely with profit growth. The logic is straightforward: as a company earns more each year, its intrinsic value grows—and its stock price will eventually reflect that. As Benjamin Graham famously observed: “In the short run, the market is a voting machine; in the long run, it is a weighing machine.” In other words, short-term prices reflect sentiment, but long-term prices reflect substance—the company’s true economic weight. II. Why Does Stock Price Fall Despite Rising Profits? If a company’s profits genuinely rise yet its stock price falls, several typical scenarios may apply: 1. The profit growth is ‘illusory’ Financial statements must be scrutinized beyond headline net income attributable to shareholders: Did non-recurring net income grow in tandem? If net income attributable to shareholders rose but non-recurring net income did not—or even declined—then the core business has not improved; instead, profits were artificially inflated by one-off gains such as asset sales or government subsidies. Such growth is unsustainable and ignored by the market. What is the quality of the reported profits? If profit growth is not matched by corresponding growth in operating cash flow—or if operating cash flow lags far behind net income—it signals ‘paper profits’: goods have been sold but cash has not been collected, resulting in bloated accounts receivable. Markets remain skeptical of such ‘credit-based growth.’ 2. The profit growth is genuine—but expectations have already been fully priced in This scenario is even more common. Suppose a stock rises from RMB 10 to RMB 50—a 400% gain—then reports a 100% profit increase. Though impressive on the surface, the market had already priced in this level of growth well in advance. For example, if the market expected a 50% profit increase but the company delivered only 30%, the result—even though 30% is objectively strong—will trigger a sell-off. Why? Because the prior high price embedded expectations of much higher growth; when those expectations are disappointed, price correction follows.

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