How do stock prices change? A four-point guide
A four-point guide to how stock prices of a company can be affected in the market.
Simply put, at a fundamental level, stock prices change primarily due to market forces of supply and demand.
The earnings of a company determine the stock price. Earnings are the profits a company makes, and in the long-run, it is the earnings that fuel any long-term company. Without making profits, no company can survive in the market over a long term period.
However, there are several other factors that go into the entire stock market equation that ultimately determine trading volumes and the turnover prices for the shares, all of which market experts, analysts and most importantly, those who buy stock, regularly have keep an eye on.
The factors that affect change in stock prices can be listed under the following five categories-
Company’s profit: A company that is earning well will naturally attract more investors who want to benefit from its growth.
Announcements by the company: These may be positive or negative and may include events occurring within a company that end up affecting their fundamentals directly or indirectly. They can include the release of quarterly financials, signing of a new client, imprisoning of the company’s CEO, FDA approval of a new drug or release of an innovative product.
Market liquidity: A third factor is the market itself. While a stock may rise and fall on its own merits, it may also benefit just by being in a "bull market." If more people are investing in stocks in general, and the major indexes are rising, a stock that might otherwise be average will nbow be affected positively. That's why it is always important to not only watch the movements of your stocks, but of the major indexes as well.
Domestic events: Upto some extent, there may be some sector-specific effect on stocks depending on major political developments in the country and the globe that indirectly affect the company and its industry. RBI’s raising interest rates, a natural disaster in the country, something happening to a politician who is related to the company do not directly affect the company’s fundamentals but they do end up affecting its stock price. In risky times or times of economic uncertainty, people tend to go for more stable options like fixed deposits.
Some other factors to consider before investing
The easy part: How the market forces work
If more people buy a stock, prices move up, and vice versa. If there is greater supply than demand, prices go down.
The tricky part: Why people invest in a particular stock
Why people invest in a stock is quite difficult to figure out considering that there is not really a fixed set of factors that go into making this decision. The price movement of a stock is usually determined by what investors feel the company is worth, in addition to the above-listed factors.
Remember: Company’s Value is never equal to stock price
One should never be making the mistake of considering that a company’s value is equal to that of the stock price. Here is an example to understand why–
Say, the shares of a company are priced at Rs 800 and the share of Company B is priced at around Rs 200. The value of a company is the stock price multiplied by number of shares outstanding.
Therefore, in this case. Company A that trades at Rs 800 per share and has 10,00,000 shares outstanding has lesser market value than Company B that has a lower share price of Rs 200 but has , say 50,00,000 outstanding shares (For company A, market value is Rs 800 X 10,00,000= Rs 80,00,00,000 whereas market value of Company B is Rs 200 X 50,00,000 = Rs 1,00,00,00,000).