Drives Stock Prices

Stock prices are sometimes a little bit of a riddle when they change daily based on news reports, economic changes and company specific news. But there are important forces behind stock price movement that are easily observed. Knowing these forces of movements is very important if you are an investor trying to learn the best decision maker in this thrilling land of stock trading. This blog will discuss some of the main market forces (i.e., company fundamentals, global economics) that can all influence a stock price movement.

1. Supply and Demand: The Base Factor

At the most basic, stock price movement is influenced by the simple principle of supply and demand. If more people want to buy a stock than to sell it, then the price goes up. Conversely, if more want to sell than buy, then the price drops.

Factors that will influence the demand-supply dynamic include perception and reputation of the firm, reports of performance, market news, and economic climate (i.e., inflation vs. recession). For example, announcements of product launches, acquisitions, mergers, and positive earnings reports will raise demand and stock prices. Conversely, news of scandals, negative earnings reports, and recalls will create sell-offs and falling stock prices.

2. Company Earnings and Financial Performance

Company performance is probably the most direct influencer of stock price. Investors keep track of earnings, profit margins, and revenue growth. Quarterly financial reports depicts performance against the company itself (i.e., its own stated targets) and the company’s competitors.

Reliable or strong financials generally imply some level of growth. The stock will garner greater investor interest which drives demand and the price upward. Poor or weak earnings, or some type of look-ahead that is perceived as not good or improving (even just a perception), can erode that confidence and lead to a falling stock price.

Moreover, guidance on future earnings offered by management can provide investor sentiment that a previous quarter’s earnings cannot compete with, because a positive corporate outlook can sometimes carry more weight than historical performance.

3. Investor Sentiment and Market Psychology

Market action can also be driven by investor sentiment and psychology about the market. Sentiment can be influenced by news articles, market rumors, worldly events, and biases due to emotion. The psychological factors are certain emotions like fear or greed.

A bull market can create overconfidence, even if there is absolutely no fundamental rationale to support a price increase, as investors seek out stocks and continuously raise prices. In the same fashion, in a bear market there will be general panic with investors rushing to get out of their positions and continue to reduce prices.

Social media could rapidly raise investor sentiment to another level. A post, tweet, or news article can go viral and produce rallies or crashes in seconds, minutes, or hours with little regard to the fundamentals.

4. News Events and Real-Time Reaction

Simply announcing new product developments, mergers and acquisitions, changes in personnel/management, and regulations will change investor sentiment sharply.

For example, if an announcement is put out over the news wires regarding a potential fraud investigation of a company, it could easily initiate a panic sell – off and a stock can drop very quickly. In a similar way, if a company announces a large acquisition or is a part of innovation breakthroughs, it can spike the stock price as perceived values in the future increase.

5. Macroeconomic Conditions: The Big Picture

In addition to company- specific fundamentals, macroeconomic fundamentals are very important for stock price changes. Macroeconomic factors help provide context for the general state of the economy, which generally impacts the decisions made by investors  in a more universal collective sense.

Things, such as: 

Interest Rates: The interest rates set by central banks establish the cost of borrowing. Increasing interest rates can cause consumer and company spending to decrease and consequently lowering earnings and stock prices. When interest rates are declining, companies see increased investment and stock price increases. 

Inflation: Some inflation is good, but high inflation destroys economic power and raises costs, which loses profits and shareholder total return. 

Employment data: High employment tends to lead to increased consumer spending, which is good for companies and raises stock prices. An increase in unemployment raises doubts concerning the health of the economy and generally trends toward declining stock prices.

Gross Domestic Product (GDP): GDP growth suggests the economy is growing, which could lead to higher business earnings, and higher stock price growth.

Exchange Rates: Currency exchanges impact profits in international businesses, which is even more of a problem for businesses who are international.

Also, Check – How Do Currency Exchange Rates Affect Investments

6. Valuation Measures and Market Expectations

Valuation measures are reference points for investors to understand whether or not a stock is fairly valued, taking into account the company’s past and present performance, and its future potential. The following are examples of valuation measures:

• Price-to-Earnings (P/E) Ratio: The price-to-earnings ratio compares the amount of money paid for a share of stock versus the company’s earnings per share (EPS). A higher P/E might suggest that investors expect the company’s earnings to mask an increase in the future, while a lower P/E might indicate that stock price is cheap, or the company may not achieve a great deal of growth in the future.

• Price-to-Book (P/B) Ratio: The price-to-book compares a stock’s price in the market to the book value of something.

            In asset-heavy industries, a low P/B ratio may indicate undervaluation.

• Dividend Yield: Dividend yield is the return in dividends as an investor. Investors looking for income often want stocks that have dividends at a stable (or favorite growing) level. Investors looking for income can satisfy that need and rationalize the price of a stock.

While valuation does inform the future price movement of a stock, it often is not a direct correlation. Price and performance can remain overvalued or undervalued for a long time, especially in volatile markets driven by sentiment and speculation.

7. Industry and Competition

Industrial changes can influence all companies in that industry space. For example, the recent ideation of artificial intelligence has influenced numerous tech stocks to move higher, as investors anticipate the long-term benefits of this technology. On the contrary, the impact of declining demand in industries such as oil and gas, for example, can force prices lower, not only due to decarbonization but also due to an otherwise strong company performance.

Furthermore, the company’s positioning within the competitive landscape – its market share, innovative capabilities, cost leadership positions, and willingness to adapt – can impact stock price and valuations.

Final Thoughts

Stock price is not a function of one single factor; it is a composite of multiple and inter-related factors: the company’s fundamentals, investor psychology, macroeconomic event conditions, and market behaviour. When all of these move together, stock price will increase, and when they pull apart, stock price will inevitably drop.

Short-term responses to price action may respond more to news and sentiment, but long-term price trends in stock price movement will ultimately line up closer to actual performance and the overall economy. By understanding these important aspects of market activity, investors should be able to better assess market trends, as well as better assess their own investment routes and expectations.

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.