Question 3 (40 marks)

On 28 January 2011, GPG Systems Ltd. announced its fourth-quarter results for 2010, its best quarterly results ever. Despite $2 million in losses resulting from the December 2010, Argentine currency devaluation where the company had just begun work on a big government contract, its net income grew to $8.85 per share compared to $5.65 in the same quarter a year earlier in 2009. Also compared to that same quarter, revenue jumped by 35%, taking GPG into the No. 1 market share position among its competitors in Canada. On top of this, profit margins had increased by approximately 10%.

In spite of all the good news, GPG's share price took a beating on 28 January 2011, dropping by $7.50 from $62.50 the day before. The Globe and Mail reported that for almost two months, the consensus of analysts' predictions for fourth quarter earnings had been steady at about $9.70 per share. In addition, just before the fourth quarter results were reported, a feature article appeared in the Financial Post suggesting that GPG was over-extending itself with its foreign sales push since, to gain this revenue growth, it was relying on newly hired and ill- trained foreign staff to complete very large contracts in countries it had little experience working in. Moreover, pointed out the Post article, it was one thing to win the contracts with competitive bids and another thing to carry them out profitably.

Two days before the company released its 2010 fourth-quarter results, the president, Steve Morin, released a statement acknowledging that the upcoming quarterly statements would show a significant drop in Canadian dollar revenues from its activities in Argentina on account of the peso devaluation, but that the net effect would be considerably less since most of the project's expenses would be smaller in Canadian dollars as local salaries were contracted in pesos as well. He further pointed out that this work represented less than 10% of GPG's new foreign business. Without mentioning the Financial Post article directly, he took pains to defend his strategy of pursuing foreign business, emphasizing his line managers' experience in supervising large contracts, both in Canada and abroad. "Our financial results over the past year bear this out," he argued. Moreover, he added, "the market could expect to see our revenues, both domestic and foreign, continuing to grow at about the same rate as last quarter."

Required--1 Page Maximum

A. (15 marks) Using efficient market theory, explain why the share price fell on 28 January 2011.

B. (15 marks) Using behavioural finance, explain why the share price fell on 28 January 2011.

C. (10 marks) Which of these two explanations for the fall in GPG's share price do you find

more convincing? Explain.