Stock prices show the amount someone is willing to pay for a company's shares at a particular time. Market analysts use a business’s past and present performance to predict future outcomes and determine a share's cash worth.
The price of a stock fluctuates since a wide range of factors contribute to the cost. Fundamental factors determine the long-term price trends for stocks, while technical elements have an impact on short-term price changes.
Stock Price Basics
A stock's price and a stock's value are two components of stock market fundamentals. The value of a stock is based on a business's past and present earnings, market share, sales volume over time and other similar factors.
The price tells us how much a buyer is willing to pay and how low a company is willing to sell its stocks. Somewhere in the middle lies the actual price.
A stock's price and value are usually within the same ballpark. However, sometimes stock prices can be much higher or lower than their value. Stocks have two prices, which are:
- The bid: The price buyers are willing to pay for a share.
- The ask: The price for which companies are willing to sell stock.
When demand is higher than supply, share prices go up. When supply is higher than demand, prices decrease. To understand the value of assets in the stock market, investors examine the following:
- Quoted market value: The value of the stock after the buyer and seller negotiate a price.
- Real or intrinsic value: The net present value of a company's income. This number is based on the productive capacity of a company and the amount of cash that could potentially be produced infinitely.
Companies often sell stocks for more or less than their intrinsic value. Investors may keep stocks on a watchlist if they are priced above intrinsic value. These investors may wait for the market capitalization to decrease before purchasing power shares. Some factors and circumstances can drive the price of shares up or down.
How Stock Prices are Determined
A variety of internal and external factors influence stock prices. There's no formula to predict stock price behavior since a number of factors can impact prices.
In an optimal stock market, stock prices would be based primarily on fundamental factors such as these two key components:
- Earnings per share (EPS): Companies allocate a portion of their profits to outstanding shares of common stock.
- Price-to-earnings (P/E) ratio: This trading multiple is the stock's current price relative to the company's earnings per share.
Stock analysts use these values to predict the future tendencies of stock prices. Additional factors, such as the perceived risk of the stock, discount rate and expected growth also come into play when setting future expectations. Technical factors refer to all the external factors that can cause stock prices to increase and decrease. These can include:
- Trends: Sometimes stock prices change according to short-term trends. Stocks can gain momentum, either gaining popularity or losing value quickly.
- Economic strength: Company stocks often mirror the current state of the economy. In times of prosperity, stock prices see favorable increases; during recessions, stock prices can go down, affecting companies in similar industry segments.
- Inflation: During times of inflation, stock prices see favorable increases in companies' pricing power. On the other hand, periods of deflation cause stock prices to drop and businesses to lose value.
- Liquidity: This term describes how much attention a stock receives from investors. Large corporations tend to be well-known and receive more attention. Small businesses have more difficulty gaining publicity, even if they have strong investment portfolios.
- Interest rates: Rate hikes can decrease the value of stocks since they put pressure on future earnings. Interest rate hikes also increase the cost of borrowing money, which hurts companies that are financing big projects.
These are just a few technical factors that can cause stock prices to rise or fall.
Many factors can cause stock prices to change, including market sentiment or the effects of sociological and psychological factors that contribute to fluctuations in stock prices.
Since market sentiment is a subjective area, it makes it difficult to predict its impact on the market. All these factors help set stock prices and predict future outcomes.
How Stock Splits Impact Prices
While many uncontrollable factors influence share prices, corporations are in control of a few factors, such as stock splits. Companies use stock splits to adapt their prices favorably.
Stock splits do not change a company's market capitalization. These splits take the same apple and cut it into multiple pieces. A company conducting a 10-for-1 stock split will see its stock price of $1,000 per share go down to $100 per share.
Some companies initiate stock splits to remain eligible on public exchanges such as the New York Stock Exchange. These types of splits are known as reverse splits. For instance, a company trading at $0.50 per share may do a reverse split to get the share price above $1 per share.
These companies tend to do large reverse splits, such as 1-for-100 to avoid initiating too many reverse splits within a short timeframe. Investors with less than 100 shares end up with fractional shares after reverse splits go through.
Other companies initiate stock splits to make their shares appear more affordable. Investors may feel more inclined to buy shares at $100 per share than at $1,000 per share even though the company's market capitalization has not changed. Amazon feels more affordable at $130 per share than $2,600 per share even though investors should look at the P/E ratio, financials and other metrics when assessing fair value.
Some investors pile into stocks leading up to their split dates due to the fear of missing out. This phenomenon is more common during bullish markets for stock splits with plenty of anticipation and coverage.
Understanding the Mysteries of Stock Prices
Stock prices can be different from the actual value of the stock. The share price refers to an agreed-upon sum, which the buyer and seller negotiate for an asset.
The bid price is how much buyers are willing to pay for shares. The asking price is how much money companies are willing to sell a stock. To understand stock prices, consider the factors that contribute to fluctuations in their value. Fundamental factors, such as the earnings base, play a pivotal role.
Technical factors, such as inflation, liquidity and economic strength, impact short-term changes. Market sentiment, along with sociological changes, can cause prices to go up or down. An online stock broker can help you navigate these challenges.
Frequently Asked Questions
What makes a stock price go up?
Rising demand for shares and reduced supply through stock buybacks can cause a stock’s price to go up.
Is a high stock price better?
A high stock price does not indicate a good or a bad investment. Investors must look at a company’s fundamentals to assess if the stock is overvalued, undervalued or fairly valued.
How do stock investors make money?
Stock investors make money from asset appreciation, dividends and reinvestments. The stock market is a long-term investment vehicle that also creates opportunities for traders.