A Brief Guide to Stock Price Changes
Share this article:
By John Alexander Adam
The factors that impact the value of a company’s stock can appear a complete mystery to the uninitiated. How can tech companies yet to make a profit, or even break-even, achieve market capitalizations in the billions? And why do investors pay more for stock in some companies making far less money or profit or both than others? Stock market valuations are complex. Companies in different industries and with different kinds of activities are valued in a different way as are companies at different stages of maturity. Even the experts don’t always agree on exactly how or why to value different companies in different ways. But that is also part of the inherent competition of trading and investing in the stock market. To be successful, anyone buying or selling stock must decide on the direction the value of that stock will take before it does so. While hundreds of whole books have been written on the details of the many factors that can influence the direction of stock prices, here’s a few of the main ones described in brief.
A company’s fundamentals are the most traditional way to value it. Fundamentals include the company’s revenues, profit margins, operating costs, assets and liabilities. They pay no attention to current popular sentiment around the company and look at only the hard, stripped down facts of its current financial strength. If investors believe a company’s fundamentals are strong or weak in comparison to its current stock price this will, over the longer term, influence the trend of its share price up or down.
Technical analysis of a company’s worth is almost the opposite of a fundamental valuation. A technical assessment of stock price focuses on patterns in buying and selling behavior. By looking at charts and applying different theoretical principles, investors believe that the past pattern of the stock’s price provides a good indication of its future direction. Technical analysis often becomes a self-fulfilling prophecy with short term traders controlling vast sums of money following technical analysis principles. As a result, when a trend starts to take shape billions of dollars start to be placed on that trend, either through the buying or selling of stock, which drives the market further in that direction. This relies on the principle of interpreting general investor sentiment and tends to mainly impact stock price valuations in the shorter to medium term.
If we go back to the example of companies being assigned huge values while making little or no profit, the main reason for such seemingly ludicrous valuations is their market share, or rather, the growth trajectory of their market share. It could be an entirely new market the company is creating for itself, such as in the case of social media giants Facebook and Twitter, or it could be an existing market they are making quick inroads into through an innovative approach. While not yet listed on the stock exchange, currency exchange and transfer service TransferWire is a good example of the latter. Investors will look at a company showing significant growth or loss in market share and be ready to pay a premium to get in on what they expect to be the next big thing, or take a hit by selling out of a company they consider to be on the decline.
Wider Industry Sentiment
The stock price of companies can go up or down due to investor sentiment towards the wider industry they are a part of. Finance and banking stocks for example often show valuation trends up or down without any actual change in the company’s profit, loss or market share because investors because investors believe an external factor such as a change in interest rates will impact the entire sector. Another example could be new technology meaning investors fear what a particular group of companies does could soon become obsolete.
Investors are a nervous bunch and any big shocks to the financial system, or geo-political disruption, tends to send them scurrying for the exits. When the financial crisis hit in 2007-08, stock prices crashed across the board. In theory, companies whose main activities are focused on basic goods and services, such as utilities companies, manufacturers of staple food products and so on would not see demand for their products reduced as a result of lending constraints on banks. We might choose not to buy that slightly pricey bottle of wine when things get a little tight but do we eat less bread or sit in a cold house? Nonetheless, history shows that such shocks impact general investor confidence and stock prices fall in unison, regardless of what the companies do.
There are other factors and many more sub-factors that influence stock price changes and predicting them is so complicated as they work together, pushing and pulling prices in different directions simultaneously. However, the five listed here are a good starting point that a majority of influences can be traced back to.
If you would like to improve your understanding of business and finance, why not take a qualification such as the CFA® Program! Morgan International offers a number of different professional finance, investment and accounting qualification programs at locations across the Middle East.