What Causes Stock Prices to Change?
The following lesson discusses influences that affect stock prices. We can consider the stock market a living entity because of its volatility—and stock’s ability to change price minute to minute. A number of factors may determine this change. Market forces such as supply and demand at times determine share prices. If more people want to buy a stock (demand) than sell it (supply), then the price goes up. Conversely, if more people wanted to sell a stock than buy it, supply exceeds demand and the price falls.
Many factors determine what makes people favor a particular stock and dislike another. Fundamental data such as P/E ratios and projected earnings help investors place a value on a stock. News events, positive or negative, can also influence the price of a stock. There are always varying opinions on what is good or bad for a company, so news alone is seldom the sole determining factor of price, but it can influence its change. News that moves a stock’s price may be a result of internal corporate activity, industry trends or information based upon national or international occurrences including political, social or even scientific events.
A stock’s price change indicates what investors believe a company is worth. The price of a stock not only reflects a company's current value--it also reflects the future growth and earnings that investors expect. The most important factor that affects the value of a company is its earnings. Public companies must report their earnings four times a year (once each quarter). “Wall Street” carefully watches earnings results. Analysts base their opinions about future value of a company on its earnings projections. If a company's results are better than analysts expected, the stock price rises. If a company's results are worse than expected the stock price falls.
Earnings are just one way to change investors’ opinion of a stock and ultimately, its price. Investors have developed literally hundreds of variables, ratios and indicators that help predict or determine stock price changes. Forecasting prices consistently is almost impossible. This lesson will focus on a broad and basic approach to understanding the influences of the market.
Vocabulary
Earnings: Whatever profits or net income remains after subtracting the company’s expenses from its revenue (also called a company’s profit).
Fundamental Analysis: A primary method for analyzing a stock's potential return. It involves assessing a corporation's financial history and current standing, including earnings, sales, and management, as well as the strength of the corporation's products or services in the marketplace.
Inflation: An increase in the general level of prices of goods and services.
Market Capitalization: A measure of the value of a company, calculated by multiplying the number of outstanding shares by the current price per share. For example, a company with 100 million shares of stock outstanding and a current market value of $25 a share has a market capitalization of $2.5 billion.
P/E Ratio: A company’s closing price divided by its latest annual earnings per share. The Price / Earnings is the relationship between a company’s earnings and its share price. It is calculated by dividing the current price per share by the earnings per share.
Quantitative Analysis: Analysis focused on a corporation's financial data including looking at profit-and-loss statements, sales and earnings histories and the statistical state of the economy.
Technical Analysis: Tracking price movements and trading volumes in various securities to identify patterns in the price behavior of particular stocks, mutual funds, commodities, or options in specific market sectors or in the overall financial markets.
Application Scenario
The Good House Builders Company, located in Mississippi, has been in existence for 14 years. It has had steady work for the past few years. Last summer a horrible hurricane hit Mississippi, wiping out major towns and cities in the southern part of the state. Every home and business was destroyed; people were left homeless and jobless. People are now returning after the disaster to rebuild. The only construction company in the area is the Good House Builders.
1. How will the event affect the manufacturing of homes?
2. What affect will the event of last summer have on the cost of materials that go into producing new homes? Explain why.
3. How will this event most likely affect the earnings of the company?
4. How will the event most likely affect the future of the company?
5. How do you think the event will affect the price of the company’s stock?
6. What other things do you think might have affected the stock?
7. Would you invest in this company? Explain.