Who Sets a Stock's Price?
There are many, many factors
that affect the price of a share but basically it is determined by how much
somebody is willing to pay
for it.
Perceived Value Just like any
other auction, the price is determined by the perceived value of the item
being traded. It cannot be
calculated or determined by a formula. A good example
is that house prices fluctuate on
a daily basis even though the actual houses are not physically
changing.
Biggest Factor - Earnings
Probably the biggest factor in determining the price is the company's
earnings (profits), both now and future projected earnings. Each
quarter, every publicly-traded company is supposed to publish
its projected earnings per
share for that quarter. At the same time, market
analysts publish their predictions
for many of those companies.
If the company falls short of
their own projections or the analysts' predictions, the price will often
fall five percent or more.
That is because the price before the actual earnings
announcement was made was based on
estimates that turned out to be inaccurate. On the other hand, if a company
announces projections of
much larger earnings than investors were
expecting, the price would
probably go up because the future perceived value would then be
higher.
Intra-Day Factors Many stock
prices fluctuate one to five percent throughout a trading day. Is this
because the company's real
value is changing that much throughout the day? Probably
not. These fluctuations are mainly
due to factors outside the company, including: - What the market is doing
today (up, down, etc.) -
Other stocks in the same industry - World news, such as
oil prices and terrorist attacks -
Day traders trading large quantities of shares and affecting the price
Although these factors may
not be related to the actual company, they have a
very real impact on the
price.
Long-Term Factors The biggest
long-term factors have to do with the company's actual financial performance.
Therefore, the long-term
price should reflect what the company is actually
worth. Here is a partial list of
these factors: - Earning now - Earnings for future quarters - Prospects for
new business - Amount of
debt - Competitors
The Price is Wrong It is quite
common for a stock price to be significantly higher or lower than it is
really worth. This can be
due to external factors, such as what the overall market
or economy is doing, or it
could be a temporary overreaction by investors due to rumors about the company,
whether they are true or
not. In these cases, it could be said that the price is
"wrong," and that creates an
excellent trading opportunity.
A great example of overreaction
would be like when Apple announces a great new gadget and thousands of
investors go load up on
APPL shares. This creates a supply and demand issue
where there is not enough
supply to meet the demand of the buyers, so
naturally the price will go
higher and higher. The actual value of the company should actually increase
because their sales will go up thanks to this new gadget, but the
share prices may temporarily exceed the actual value of
the company due to this buying frenzy. Again, that can create a
great trading opportunity.
About the author:
Nicholas Swezey is the creator of
the Stock
Market Simulation
at
HowTheMarketWorks.com.
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other popular articles on the stock market.
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