How share prices increase or decrease is a question every investor, experienced or novice, asks. Price fluctuations may occur due to various factors like changes in expected earnings, demand and supply factors, or news related to the company. When share prices increase, they may increase for a number of reasons.
This article lists a few factors like demand and supply functions and market sentiments that affect how prices change.
FACTORS AFFECTING STOCK PRICES:
How Do Demand and Supply Affect Stock Prices?
The share market works like any other market. The stock prices are determined by the market forces of supply and demand. The factors affecting the demand and supply in stock markets would, in turn, affect the stock prices.
Suppose a trustable report shows that a company is not doing well or worse than expected. In this case, fewer people will want to buy this company’s shares. So demand will drop. At the same time, more people will want to sell the shares, which indicates a rise in supply. This will lead to a drop in stock prices as the supply exceeds demand.
Positive news usually has the opposite effect on the demand and supply of such stocks.
It should be noted that supply and demand curves always have to be estimated based on investor behaviour and market conditions.
How Do Company Earnings Affect Stock Prices?
Prices of stocks are often described as estimates of the real value of all future earnings from a stock. So, when company earnings underperform, the stock prices should also decrease. When a company fails to meet expectations or exceeds the market expectations, we might see a related change in stock prices.
Good or Bad News Affecting Stock Prices
Stock markets might be affected by relevant good news and bad news. In theory, the good news about a company will increase its stock’s demand and price. In contrast, bad news about a company will decrease its demand price.
Any good news for the stock market or a particular stock would be something that makes you feel more confident about their profitability. Similarly, any bad news for the stock market or a particular stock would be something that makes you feel less confident about their profitability.
Overvaluation and Undervaluation
We often hear people say that the stock market is overvalued or that the stock market is undervalued. They mean that the stocks in a market or market index are not valued correctly, and their prices are likely to change in the direction of the intrinsic value (the perceived value based on various factors).
When a stock is overvalued, i. e. the stock price is higher than it should be, there might be a fall in the price of that stock. On the other hand, when a stock is undervalued, i. e. the stock price is lower than it should, be, there might be a rise in the price of that stock.
People may often use the P/E ratio (price to earnings ratio) and PEG ratio (price to earnings growth ratio), along with other parameters/ratios, to understand whether a stock is overpriced or underpriced.
Technical Factors Affecting Stock Prices
The mix of external factors that affect stock prices is called technical factors. These factors include macroeconomic conditions (growth expectations of an economy, international trade situation, etc.), the strength of substitutes and complementary businesses, incidental transactions and demographics.
Inflation Affecting Stock Prices
The effect of inflation on stock markets varies depending on the level of inflation. Investors often closely monitor inflation levels and speculate on the impact of inflation on Indian stock markets.
A fall in stock prices due to rising raw material prices and falling demand from consumers is an effect of inflation on stock prices. Deflation also affects stock prices. Deflation is seen as a sign that the economy produces more than it wants. Thus industries stop expanding, and some businesses might even shut shop due to low demand.
Substitutes Affecting Stock Prices
Suppose there are 2 companies in the soda market: Sada Soda and Naya Soda. If Naya Soda starts outperforming its rival, its stock prices might rise. At the same time, Sada Soda might experience a fall in stock prices.
The presence of competing products can be a hindrance to the growth of a company.
Institutional Transactions Affecting Stock Prices
Sometimes, news of institutional investors investing in a particular stock or selling a particular stock might affect the demand for a stock. Suppose we hear that a very highly reputed institutional investor who manages crores of rupees decides to buy a lot of shares of a particular company. Investors might expect the stock price of this company to rise.
Thus, transactions made by reputed investors might affect stock prices as well.
Effect of Changes in Demographics on the Stock Prices
Demographics refers to the statistical data about a population and the groups (by age, region, etc.) within it. Some companies might sell products meant for only a certain demographic, i. e. people from a certain age group or region.
The demographic of stock market investors might not affect stock prices as much as the target audience’s demographics.
Trends Affecting Stock Prices
Trend analysis predicts future stock price trends based on existing data about stock prices and variables like the P/E ratio. Trend analysis assumes that stock prices follow a certain pattern.
Liquidity Affecting Stock Prices
In the stock market context, liquidity can mean 2 things. Firstly, it may refer to the ratio of a company’s assets that can be quickly converted into cash without losing value. Or it may refer to how easily you can purchase or sell a particular stock without losing too much money.
When a company has low liquid assets, it might have to rely on external debt to interest payments and might get stuck with higher debt.
If you can’t sell a stock easily without losing value, you might get stuck with losses in that stock. So, when investors see that the trading volumes of a stock are dropping, they might sell such shares, leading to a fall in prices.
Market Sentiment Affecting Stock Prices
Market sentiment refers to how all investors feel about a stock or a market. We often hear people say things like, “investor sentiment in the stock market remains bullish”. Basically, they mean that based on the recent investing activity, the stock market might still rise.
The sentiment of the stock market is measured using trend analysis of the stock price. Some of the indicators used to read the sentiment in the market are volatility indexes (VIX), high-low indexes, bullish per cent indexes and moving averages.
Final Thoughts
There are numerous reasons why stocks go up and down. Stock prices might move based on market sentiments, liquidity, trends, technical factors and demand and supply functions. When you are investing in a particular stock, it is important to stay vigilant about news and reports that could affect its prices.
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FAQs
As the demand and supply for stocks fluctuate throughout the day, it causes the stock prices to move as well. The demand and supply functions for stocks are affected by reports and news of the company’s performance and expected performance including other factors.
Accurately predicting stock prices is extremely difficult due to the various factors that could affect a business and the demand and supply of a stock.
A reason for stock prices to go down after good earnings would be a fall in expected future sales or earnings. Developments that cause decreases in future value expectations can be a reason why stock prices might fall alongside good news.
Berkshire Hathaway is considered to be the most expensive stock in the world which was trading for $4,58,675 per share in January 2022.
