Skip Navigation. Jennifer Liu. VIDEO This grandmother's advice helped create a self-made millionaire. Your Money's Worth. The Definitive Guide to Business. If more people want to buy a stock demand than sell it supply , then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall.
Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies.
That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don't equate a company's value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding.
Part of these earnings may be distributed as dividends , while the remainder will be retained by the company on your behalf for reinvestment. We can think of the future earnings stream as a function of both the current level of earnings and the expected growth in this earnings base. Although we are using EPS, an accounting measure, to illustrate the concept of earnings base, there are other measures of earnings power.
Many argue that cash-flow-based measures are superior. The way earnings power is measured may also depend on the type of company being analyzed.
Many industries have their own tailored metrics. Relatively mature companies are often measured by dividends per share, which represents what the shareholder actually receives. The valuation multiple expresses expectations about the future.
As we already explained, it is fundamentally based on the discounted present value of the future earnings stream. Therefore, the two key factors here are:. A higher growth rate will earn the stock a higher multiple, but a higher discount rate will earn a lower multiple. What determines the discount rate? First, it is a function of perceived risk. A riskier stock earns a higher discount rate, which, in turn, earns a lower multiple. Second, it is a function of inflation or interest rates , arguably.
Higher inflation earns a higher discount rate, which earns a lower multiple meaning the future earnings are going to be worth less in inflationary environments. In summary, the key fundamental factors are as follows:. Things would be easier if only fundamental factors set stock prices.
Technical factors are the mix of external conditions that alter the supply of and demand for a company's stock. Some of these indirectly affect fundamentals. For example, economic growth indirectly contributes to earnings growth.
Technical factors include the following. We mentioned it earlier as an input into the valuation multiple, but inflation is a huge driver from a technical perspective as well. Historically, low inflation has had a strong inverse correlation with valuations low inflation drives high multiples and high inflation drives low multiples. Deflation , on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies.
Company stocks tend to track with the market and with their sector or industry peers. Some prominent investment firms argue that the combination of overall market and sector movements—as opposed to a company's individual performance—determines a majority of a stock's movement.
For example, a suddenly negative outlook for one retail stock often hurts other retail stocks as "guilt by association" drags down demand for the whole sector. Companies compete for investment dollars with other asset classes on a global stage. These include corporate bonds , government bonds, commodities , real estate, and foreign equities.
The relationship between demand for U. Incidental transactions are purchases or sales of a stock that are motivated by something other than belief in the intrinsic value of the stock. These transactions include executive insider transactions, which are often pre-scheduled or driven by portfolio objectives. Another example is an institution buying or shorting a stock to hedge some other investment. The VIX averaged Keep in mind that even with careful research, investing always carries some inherent risk.
An easy way to do this is by primarily investing in ETFs and index funds instead of individual stocks. Index funds and ETFs are great ways to build wealth with relatively low maintenance and low barriers to entry. Ultimately, though the stock market may have its ups and downs in the short term, investing is a great way to build wealth in the long term.
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