With all assets influenced by the shifts in supply and demand, stocks can be thought of like a giant auction, where investors bid for other stocks while selling stock of their own. The greater the interest in a stock, the less willing bidders and current shareholders are willing to sell their stock, resulting in an increase in demand, causing the share price to rise in value. Conversely, if supply outstrips the demand then the price will fall.
What determines investors’ general interest in a stock?
The principal factors affecting share prices are the performance of a company and the wider environment.
1. Public companies are required to report once each quarter. These statements and figures provide the investment community with an understanding of the overall company performance. Earnings season is the most awaited times of the year where the analysts base the future value of a company and earnings projections; altering to a great extent the sentiment towards a stock within the investment community.
2. Companies are obliged to notify any event that influences their share price. These announcements must be made via regulatory announcements on a RIS (Regulatory Information Service) before being published elsewhere. In addition to this, investors gather company information in many other forms: press releases, news stories, court filings and even social media sources such as Tweets. Investors unconsciously react to every piece of information and collate an overall impression of a stock which leads them to buy, hold the shares they have, or even sell.
3. The wider environment such as economic conditions has a direct effect on share price. If the economy is in good condition and is expected to remain, this leads to an increase in investors’ confidence. When there is a positive outlook on the health of the economy, companies are expected to perform better and deliver stronger results, which then increases the likelihood of them paying solid dividends. However, if the economy is expected to face a downturn, this increases fear amongst investors. In turn, this fear that the company may fail to cope accordingly causes a reduction in demand and the share price to plummet.
When dealing in an effective market condition, stock prices are defined via fundamental analysis. This is an in-depth study of a company’s financials to determine the value of its shares. These are constituted by two areas:
1. Earnings base: Earnings per share (EPS): when shareholders buy a stock, they are purchasing a proportional share of a future stream of earnings within a company. EPS is generally considered as the single most important variable to value share price. The reason for this is that this metric is used as a barometer to assess a company’s profitability per unit of shareholder ownership.
2. Valuation Multiple: P/E ratio: this is based on the discounted present value of the future earnings stream of a company. The two main factors accounted here are the growth of the EPS and the discount rate used to define the present value of a prospect stream of earnings. High growth rate leads to a higher multiple, but this is influenced by a discount rate which will lead to a lower multiple. Discount rates are affected by perceived risks on the stock and by a function of inflation. Higher inflation leads to higher discount rates which in turn lowers the valuation multiple and future earnings worth.
The following are a collection of external factors influencing the supply and demand of the stock in a company. Historical prices are also used when conducting a technical analysis as a means of recognising patterns to facilitate the prediction of stock prices. The main influencing technical factors in stocks include:
1. Inflation: As a huge influencer on the economic outlook affecting overall share prices. If inflation and interest rates increase resulting in poor financial outlook, this will directly proportionally affect demand negatively causing share prices will drop and companies to face a loss in pricing power.
2. Strength of competition and industry trends: Company stocks tend to be benchmarked and tracked against their peers within the industry they operate. The investor community tends to determine the movements of a stock upon the overall market and sector performance, rather than individually. This is mainly because companies in the same industry are subject to the same pressure and tend to perform similarly.
3. Market sentiment: This refers to the overall perception that traders have about a stock. Even though this may be a purely psychological indicator, investors are greatly influenced by market waves instead of purely referring to financial indicators. This may be seen as subjective; however, it is usually used in addition to technical analysis on the company to estimate share price movements.