Cockroach theory is the idea that one item of bad news is an indication that there is more bad news to come: in the same way that seeing one cockroach is an indication that there are more lurking out of site.
There are many reasons why it is credible that bad news comes in batches. for example:
- A company may try to smooth earnings, so that the full effect of a deterioration will only become evident over several results announcements.
- A company may be worried about the impact on the price of the sudden release of too much bad news, and delay some announcements as much as possible.
- Bad news from one company in a sector may indicate worsening conditions in the sector, which will therefore mean more bad news can be expected from other companies in the sector.
- A particular item of bad news may be a symptom of underlying problems, such as bad management, which will naturally lead to more bad news.