Still, the fact that prices did move that much demonstrates that there are factors other than current earnings that influence stocks. Investors have developed literally hundreds of these variables, ratios and indicators. So, why do stock prices change? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stocks will change in price while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell.
The only thing we do know as a certainty is that stocks are volatile and can change in price extremely rapidly. The important things to grasp about this subject are the following: At the most fundamental level, supply and demand in the market determine stock price. Price times the number of shares outstanding market capitalization is the value of a company. Comparing just the share price of two companies is meaningless.
When companies go public, shares are offered to stock investors in exchange for cash. As the stock price goes up, the company receives more cash in exchange for the one share it has to offer. In effect, this gives the company more money with which to invest in itself.
Increasing share prices indicate that investors are expecting higher earnings growth from the company in the future. As the company invests in itself, its potential value for greater earnings increases.
Investors will be attracted to this potential. In the short term, things like quarterly earnings reports that beat expectations, analyst upgrades, and other positive business developments can lead investors to be willing to pay a higher price to acquire shares. On the flip side, disappointing earnings reports, analyst downgrades, and negative business developments can cause investors to lose interest, thus reducing demand and forcing sellers to accept lower prices.
In the long term, the value of a stock is ultimately tied to the profits generated by the underlying company. Investors who believe a company will be able to grow its earnings in the long run , or who believe a stock is undervalued , may be willing to pay a higher price for the stock today regardless of short-term developments. This creates a pool of demand undeterred by day-to-day news, which can push the stock price higher or prevent big declines.
Sometimes demand for stocks in general increases, or demand for stocks in a particular stock market sector increases. A broad-based demand increase can drive individual stocks higher without any company-specific news.
One example: The COVID pandemic led to consumers increasing spending online at the expense of brick-and-mortar stores. Some investors believe this change is here to stay, which led to an increase in demand and higher prices for e-commerce stocks across the board.
Another example: Falling interest rates reduce what savers and investors can earn from savings accounts and fixed-income investments like bonds. This can lead those looking for better returns to invest in other assets, like stocks or real estate, thus raising the demand for those assets and inflating prices. Key Takeaways A company's stock price reflects investor perception of its ability to earn and grow its profits in the future.
If shareholders are happy, and the company is doing well, as reflected by its share price, the management would likely remain and receive increases in compensation. The prevention of a takeover is another reason that a corporation might be concerned with its stock price. If a company's stock price is performing well along with the company, the company is likely to receive more favorable press from analysts and the media.
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Investopedia does not include all offers available in the marketplace. Related Articles. Investing Understanding Corporate Actions. Partner Links. What Is Fundamental Analysis? Fundamental analysis is a method of measuring a stock's intrinsic value. Analysts who follow this method seek out companies priced below their real worth. Dividends: A Complete Guide A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors.
The Ups and Downs of Price Changes A price change is the difference between a security's closing price on a trading day and its closing price on the previous trading day. Value Investing: How to Invest Like Warren Buffett Value investors like Warren Buffett select undervalued stocks trading at less than their intrinsic book value that have long-term potential.
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