How fundamentals, emotions and economics influence the share price of a company.
The current stock price of company shares is based on the supply and demand of shares on the stock market. Every moment throughout the day there will be sellers who are willing to sell their shares to buyers who want to buy them. As a result if there is a lot of demand for stocks on the market the price will rise and if there is little demand the share price will fall.
However the underlying reasons for daily fluctuations in stock prices differs between the short-term and long-term. In the short-term demand is primarily influenced by market sentiment which can be influenced by news, social media, new earnings reports or the general state of the stock market. However in the long run fundamentals play a bigger role in regulating demand for shares. They define the value of a company based on their numbers rather than sentiment. This difference between short-term and long-term thinking is also reflected in the difference between trading and investing.
“Price lies all the time. Facebook can be valued at $40 billion and then $20 billion and then $200 billion inside of a four-year period of time. Which of these prices is the truth? None of them. But all of them were momentarily true, until they were rendered a lie, and a new truth was forged in the fires of the marketplace. Sunrise, sunset. Prices change and, with them, the truth itself.”
In the end the market is a reflection of how companies and industries are being valued in society. Rising companies or industries will be valued higher than declining ones as their future impact is expected to be reduced. Markets always anticipate the future and the share price at any given moment reflects the combined “market opinion” of all market participants about the future of a company. As a result while an investor might have a contrarian view about the value of a company ultimately the market decides its value through its participants.
Fundamentals are factors which are contributing and defining the underlying value of a stock. These fundamentals can be both quantitative values based on the balance sheet, income statement and other financial statements of the company as well as qualitative based like the competitive advantage and business model of a company.
These factors play an important role in determining the level of confidence investors might have in the future performance of an investment. As investors want to ensure that their investments will have limited risk and a predictable outcome they tend to invest into companies with better fundamentals. Consequently companies with better fundamentals tend to have higher stock prices than companies with high uncertainty.
Some fundamental factors investors will look at are the historic growth rate of sales and earnings as well as the future growth potential. This includes an analysis of how target markets of the company are growing in addition to the company’s competitive position within each of those target markets. It is important to not only understand the current position in these markets but to also understand how the company will maintain or improve it in the future. The future growth potential is often expressed by calculating the earnings per share for a given company.
In addition investors they might compare the company with competitors within the same target markets. Generally companies with a monopolistic position will have better fundamentals as companies within a competitive environment as those are shrinking profit margins.
Apart from the expected development investors should also understand the current state of the company. This includes the cost structure of the company which directly impact operating margins. If a company is able to reduce its costs margins will be expected to expand which will lead to a higher share price. Similarly contracting margins will likely lead to a reduced share price.
Similarly debt should be watched carefully as it determines the future viability of a company. If the company has lots of debt it might have a harder time to attract new capital through banks, bonds or other investors and therefore has a higher risk of going bankrupt. At the same time the increased interest payments also lead to reduced future cash flows which will be distributed to investors either through dividends or an increasing stock price.
Every public company is obligated to release their latest corporate earnings and financial information on a regular basis. Typically this includes quarterly and annual earnings reports. These company earnings releases are always met with a lot of expectations by investors as they expect them to confirm or decline their own estimates. The general expectations of investors will be priced into the share price before the earnings release already. However if the earnings of the company will turn out better than expected the market will likely react with rising demand and therefore rising share prices. Similarly worse than expected earnings will likely cause a sell off by investors.
Dividends are distributed profits that companies pays out to its shareholders.They are usually paid at regular intervals, such as quarterly or annually. Dividends can impact the share price through the introduction, change or cancellation of a dividend.
When a dividend is announced the company will declare an ex-dividend date. All shareholders which own the dividend before this date will be entitled to receiving the dividend. Therefore the share price of a company is usually rising shortly before the ex-dividend date and then falling again afterwards.
The fall of the share price after a dividend has been paid to its shareholders is also a result of the value of the company shrinking because part of its reserves and cash balances have been distributed. However the price might not always impacted by dividends as for some companies which pay regular dividends the price already reflects those.
Similar to the introduction of a dividend its change or cancellation will also result in market reactions. If a company decides to increase a dividend the share price will most likely rise. Similarly on a decrease or cancellation of a dividend it will likely fall.
Many investors adopt investing approaches with little long-term success which are often driven by greed and the latest fad of Wall Street. As a result the price of a stock might simply rise because the company is related to the latest market price in some way. Recently crypto, cannabis and electric mobility stocks have been popular which caused their stock prices to go up not based on the fundamental growth opportunities of the specific companies but because of enthusiasm for the industries in which these companies operate in.
Both bad and good news can influence the share price of a company. These news can be both internal and external in nature either as a result of a direct company action or due to external factors.
Bad news causing a decline in share prices could be product recalls, employee layoffs, the departure of key personell, new lawsuits against the company, accounting errors, natural disasters, political decisions or positive news from competitors. At the same time good news causing a increase in share prices include securing a large contract, the introduction of a new product, new patents being approved to the company, the hire of top personell, the sale of a company division or an expected merger or acquisition.
It is important to remember that financial commentators and the media industry are always looking for the next big story. Therefore every new piece of information should always be examined with an critical eye to understand the impact on the company and its share price. Another point to consider is that news articles mainly have short-term influences on the share price and the long-term impact is often negligible.
Similar to the impact of news articles social media can also have a significant impact on share prices. A single tweet made by the CEO of a public company might result in rising or falling prices. Similarly customers have gained much more impact on stock prices through viral social media posts about bad customer experiences.
Economic factors can have a big influence on stock prices. Investors will be generally more bullish about the stock market when the economic outlook is favorable and the stock market is expected to rise. Similarly they might be bearish when investor confidence is low. As a result share prices might fall.
One main influence on financial markets is the level of current interest rates. When interest rates are low market participants, both investors and companies, tend to borrow more money to invest leading to higher share prices. Increasing interest rates on the other hand can lead to sinking stock prices as money is not as easily accessible.
Another factor is inflation which is usually understood as a negative influence on stock prices. High inflation increases the costs of borrowing capital, increases the costs to produce goods and therefore decreases expected earnings growth. At the same time rising prices reduce the standard of living for most people causing a further decline in sales.
The political climate will also directly influence the economic outlook. In times of instability market participants might be more cautious and have a more negative view on growth opportunities. Positive announcements such as trade deals or tax decreases might brighten the outlook and raise share prices on the other hand.
Besides fundamental factors the current sentiment of market participants can impact stock prices greatly in the short run. The science of physiological influences in the stock market is explored in the field of behavioral finance. It reveals that investors tend to be excessively greedy when the future looks good leading to rising share prices. This is a result of overemphasizing positive developments and data. At the same time investors react with excessive fear when the outlook seems to look less rosy which will cause drops in the price of a company share.
Many retail investors can make the mistake of purchasing stocks without prior research on a fundamental level. This may lead to incidental purchases which were done based on a positive sentiment rather than a well researched decision.
A stock split occurs when a company decides to increase the supply of outstanding shares without changing the proportional ownership of a company. Companies usually opt for stock splits to make their shares more attractive for retail investors. This results in more growth potential for the price of the stock as the reduced price makes the stock more accessible to a broader segment of the market. As a result stock splits tend to result in growing share prices.
Learn more about fundamental investing concepts in this recommended post.