How are stock prices determined?
I understand that by buying stocks you are essentially buying a part of the company and thus more profits for the company better the stock price. But then, is it also not determined by demand and supply? (More people buy the stock the higher its price).
My main question: Does this essentially mean that if a company is going into losses (technically its stock price should fall) but for some reason a lot of people are continuing to invest into it (keeping the demand high) mean that the share price continues to rise? Finally, does this mean stock price is determined by the mentality of people who are investing into it and not the company itself?
A simple way to put it: stock prices are determined by the price people buying/selling the stock value it.
In technical terms, It’s a market. You have people bidding for shares, and people trying to sell shares. The market is formed by this dynamic, where buyers generally bid lower than sellers ask for the shares, and the resulting price of the stock lands somewhere in the middle.
Example: I’m selling a Lolapalooza ticket on craigslist and asking for $500. Someone offers to buy it for $300. We compromise and I sell it for $400.
Hi! Thanks for the reply :)
But does this then mean the stock price has no connection with how the company is performing?
(Ahh this is super confusing cause why would I want to invest into a company that's not doing well. But then again, if the share price is not determined by the companies performance, why would that even matter?)
Also, this is leading me to question on what basis am I supposed to invest into a company then? How does one go abt predicting the market value?
Hope I could make myself clear Cheers!
Well a company’s performance, and how well it meets its performance targets, will have a direct effect on how traders value its shares. If a company like Netflix predicts it will bring in 5 million new users In Q3 and only brings in 2.5 million, its growth is reduced, and there may be more underlying problems that led to this shortfall. People who own the shares may see that the stock price will subsequently fall, and they’ll want to sell while its still high, which leads to a selloff and thus a drop in share price.
If people believe the company will perform better, they will be willing to pay a higher price for the stock.
In the long term, the reason why somebody would want to hold a stock for a company that is doing well is because they expect to have a cash flow from that company such as stock buybacks from the company or dividends. That is the more intrinsic reason. Theoretically, if a company never ever had or planned to have any cash flows to stock holders, then there would be no fundamental reason to buy its stock.
The thing is, that is really just for long term investors. Most people will invest due to the sentiment of the market.
This is all surface level stuff, as S&T isn’t my field. Plenty of people on this site and in the S&T forum will know more about this.
Plenty of companies continue to trade up or on an upward trend even if the company is losing money or hasn't made a profit yet. This can be due to a lot of reasons, but the main one I'd argue is speculation. The investors/buyers are betting the company will turn their business around and will produce profits in the future, thus getting some of those profits as shareholders.
To answer your last question, the company itself can do very little (I.e. stock buybacks, dividends) to support their own stock price other than perform well. The stock price is driven mostly by investors who determine what the company is worth based on a lot of factors. So they buy and sell the stock accordingly, thus moving the price up or down. For example. at the time of writing this, Tesla is the most valuable car company in the world. They don't make a lot of money or cars and are actually much smaller than many well established car manufacturers, but the market is betting that the company is going to take over the industry with the electric car segment. The market has determined it is that large based on its future cash flows and value.
Hey! Thanks for the reply. It was quite helpful
Could I please ask you to elaborate on some of the factors that drive the share price? (As mentioned in ur second paragraph).
A few positive factors might be things like optimism in a new project/investment the company is doing, increase in business, M&A, increase in credit ratings, strong management team, sector optimism (ex: investors are bullish semi-conductors because they believe they will be needed in the future, so the whole sector will get more investment), a famous investor/activist takes a stake in the company, etc.
These all work in the opposite way as well.
Those were just a few possible reasons as there are tons of reason why a company's share price might move. From an overall fundamental standpoint, they all stem from investors believe the company will produce more cash flow that will then be available to the shareholders.
Some mixed ideas that could be of help:
Its a good approach to think about the stock prices as a mix of risk-aversion of investor base (which derives into a higher or lower discount rates) and the perceived capacity to generate cash flows (which could be reinvested or given as dividends)
So whenever you think about profits you use it as a proxy that could yield into dividends, but be careful of the sector metrics. In Infra you could get huge dividends even with low profits if its a cash generating asset with high D&A for example.
At the end of the day consensus about performance of a company will determine the stock price. Thats why behavioural finance is important
Anyways, if companies keep beating consensus prices will go up as more people will be betting on them
The power setting on the Fed's money printer
Essentially by Supply and Demand. Look into dow theory, and you will learn a lot about it. The whole concept stems from the notion that the Markets reflect all knowable factors, and the price reflects the relationship to supply and demand. Obviously, there are events like COVID that the market cant predicts but instantly discount prices on account of these events.
THE EFFICIENT MARKET HYPOTHESIS /s
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