What causes a stock's share price to decline after better earnings?
In many instances, a stock's share price declines after better-than-expected earnings are reported. 1 Investors need to know that there is a reason for the decline in share price. It just might not be an obvious reason. 1. Major Shareholder Selling
What happens when a stock price is depressed?
That means when a stock price is depressed, doing stock-based deals gets more expensive. Meanwhile, companies can sell additional shares of stock to raise cash for various purposes, including to expand. When a stock price is falling, the company must sell more shares to raise money.
What does it mean when a stock price moves lower?
Any dramatic move in price indicates real changes in the stock market that warrant attention tempered with caution. A company's share price goes lower because more shareholders are trying to sell than looking to buy. The resulting increase in available supply forces the price lower until an equilibrium is reached.
Why do Stocks go up and down?
Everything from a breakout news story to a shareholder meeting can impact a stock’s price. A lot of times, it has to do with supply and demand, such as we saw during the infamous GameStop surge, when a collective of small individual traders drove share prices up.
Pro Tip
Investing always carries some risk. That’s why it’s a good idea to spread out your investments among many different stocks.
Fundamental Factors
The two most fundamental factors boil down to profitability and the valuation ratio, says Juan Pablo Villamarin, CFA and senior investment analyst at Intercontinental Wealth Advisors.
Technical Factors
Technical factors are things that change the supply and demand of the stock that won’t fundamentally alter the prospects of generating cash, Plumb says.
News
If you’ve ever seen a company’s stock price go up or down following an earnings call, it’s because of the news.
Market Sentiment
Market sentiment, or investor sentiment, is the investor outlook regarding a particular stock’s performance in the market. Sentiment drives demand, which also influences supply.
Why do stocks increase or decrease in price?
Stocks increase or decrease in price on the basis of what investors think the stock is worth, not directly because the company is doing well or in response to analyses of worth. If Jim Cramer of "Mad Money" pitches a stock on CNBC, that almost always immediately drives up the price more than the company's increased earnings, ...
Why does a stock move up?
A stock moves up or down in price because of investor sentiment. If investors believe a stock is worth more than its current price, it moves up. If they believe it's worth less, it moves down.
How to see how investor emotions affect the market?
To see how investor emotions affect the market, consider Everyman, a typical investor. Begin by tracking Everyman's emotional state toward the end of a bear market. Research shows that at this point in the market cycle the average investor is profoundly pessimistic and risk-averse.
Is the stock market cyclical?
The Stock Market Is Cyclical. One of the most important things for any investor to know is that the stock market is profoundly and relentlessly cyclical. Relatively independent of the circumstances of the nearly 20,000 individual companies traded on U.S. exchanges and over-the-counter, the entire stock market swings from a bull market ...
Is the stock market responsive to what investors believe?
The entire stock market is immediately responsive to what investors believe. These beliefs generally are formed more in response to investor emotion – how they feel about the stock price – than directly from an analysis of the stock's metrics –such as improved or declining earnings, the price-to-earnings ratio or earnings per share.
Why is low inflation bad for stocks?
2 Deflation, on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies.
Why do stocks move up?
Often a stock simply moves according to a short-term trend. On the one hand, a stock that is moving up can gather momentum, as "success breeds success" and popularity buoys the stock higher. On the other hand, a stock sometimes behaves the opposite way in a trend and does what is called reverting to the mean. Unfortunately, because trends cut both ways and are more obvious in hindsight, knowing that stocks are "trendy" does not help us predict the future.
What is earnings base?
An earnings base, such as earnings per share (EPS) A valuation multiple, such as a P/E ratio. An owner of common stock has a claim on earnings, and earnings per share (EPS) is the owner's return on their investment. When you buy a stock, you are purchasing a proportional share of an entire future stream of earnings.
What drives stock prices?
Stock prices are driven by a variety of factors, but ultimately the price at any given moment is due to the supply and demand at that point in time in the market. Fundamental factors drive stock prices based on a company's earnings and profitability from producing and selling goods and services. Technical factors relate to a stock's price history ...
Why do you buy stock with a valuation multiple?
That's the reason for the valuation multiple: It is the price you are willing to pay for the future stream of earnings. 1:26.
What is discount rate?
The discount rate, which is used to calculate the present value of the future stream of earnings. 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.
Where are stock prices determined?
Stock prices are determined in the marketplace, where seller supply meets buyer demand. But have you ever wondered about what drives the stock market—that is, what factors affect a stock's price? Unfortunately, there is no clean equation that tells us exactly how a stock price will behave.
Why do potential buyers have to bid higher to buy a stock?
As a result, potential buyers must bid higher to buy the stock, and the stock price moves up. This works the other way as well.
What does "buy low and sell high" mean?
This advice is the simplest explanation for how people make money in the stock market, but it falls short in explaining why the highs and lows actually happen.
What is the reaction of an investor to new information?
Of course, every investor reacts to new information differently, and those reactions can range widely from apathy to panic to euphoria. Depending on their reaction, investors may choose to buy more shares, hold the shares they have, or even sell.
Key Points
Although the stock market is a money machine over the long run, crashes and corrections are a normal part of the investing cycle.
The S&P 500's historic bounce from the March 2020 bottom could come to an abrupt halt this year
Since the benchmark S&P 500 ( ^GSPC -1.84% ) bottomed out in March 2020, investors have been treated to historic gains. It took less than 17 months for the widely followed index to double from its closing low during the pandemic.
1. The spread of new COVID-19 variants
Arguably the most glaring concern for Wall Street continues to be the coronavirus and its numerous variants. The unpredictability of the spread and virulence of new COVID-19 strains means a return to normal is still potentially a ways off.
2. Historically high inflation
In a growing economy, moderate levels of inflation (say 2%) are perfectly normal. A growing business should have modest pricing power. However, the 6.8% increase in the Consumer Price Index for All Urban Consumers (CPI-U) in November represented a 39-year high in the United States.
3. A hawkish Fed
A third reason the stock market could crash in 2022 is the Fed turning hawkish.
4. Congressional stalemates
As a general rule, it's best to leave politics out of your portfolio. But every once in a while, what happens on Capitol Hill needs to be closely monitored.
5. Midterm elections
Once again, politics isn't usually something investors have to worry about. However, midterm elections are set to occur in November, and the current political breakdown in Congress could have tangible implications on businesses and the stock market moving forward.
How to determine the value of a stock?
The important things to grasp about this subject are the following: 1 At the most fundamental level, supply and demand in the market determine stock price. 2 Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless. 3 Theoretically earnings are what affect investors' valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors' sentiments, attitudes, and expectations that ultimately affect stock prices. 4 There are many theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.
What is price times the number of shares outstanding?
Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless. Theoretically earnings are what affect investors' valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors' sentiments, ...
What is the principal theory of stock price?
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. For example, a company that trades ...
Can you predict how stocks will change?
The best answer is that nobody really knows for sure. Some believe that it isn' t possible to predict how stocks will change in price while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell.
Why do shares go down?
A company's share price goes lower because more shareholders are trying to sell than looking to buy. The resulting increase in available supply forces the price lower until an equilibrium is reached. The motivation for the selling that drives a share price lower can be company specific, such as lowered earnings expectations, loss of market share or material changes to the business. It can also be general, related to concerns about stocks as an asset class, a particular sector or the economy as a whole.
What happens when a company's shares drop?
When the shares get cheaper, the cost of buying a controlling interest goes down as well. Thus, a company whose shares have dropped sharply is subject to takeout bids and tender offers. In the long run, shareholders could benefit if the new management corrects the company's problems.
Why do companies have repurchase programs?
Benefits. Many companies have share repurchase programs in place that return capital to shareholders by purchasing stock on the open market. In theory, the resulting decrease in floating supply raises the value of each remaining share. When a company's share price drops sharply, a well-positioned management team with an existing repurchase plan can ...
Why do companies exist?
Companies exist to make money for their owners. The owners of a publicly traded company are its shareholders. So, when a company's share price drops sharply, the shareholders lose value.
Is all lost just because of the share price drops?
But, all is not lost just because the share price drops, and some good can come of it. Any dramatic move in price indicates real changes in the stock market that warrant attention tempered with caution.
Does a decline in the share price affect the company's operations?
Thus, a decline in the share price does not necessarily affect the company's operations directly. It does affect the value of employee stock options and possibly pensions, and the shares the company might itself own, if any.
What are the secondary effects of stock price declines?
Remember, a company's stock can be used as a sort of currency. Companies can sell additional shares of stock, for instance, to buy other companies.
What happens to the company's fortunes when the stock price falls?
If a stock price is falling, they may miss out on bonuses or might suddenly find their jobs on the line.
Why do companies sell more shares of stock?
Meanwhile, companies can sell additional shares of stock to raise cash for various purposes, including to expand. When a stock price is falling, the company must sell more shares to raise money.
What happens to the stock market after the initial sale?
But after that initial sale, the shares then trade hands between investors outside the company, including mutual funds, pension plans and individuals. If the stock price falls, these investors lose money, not the company. There are some very serious secondary effects, though, on a company resulting from stock price declines.
Does a falling stock price hurt a company?
A falling stock price doesn't directly hurt a company, since it also got the money for those shares. Companies with depressed stock prices might be forced to resort to borrowing or holding off expansion. CEOs and executives also have a vested interest in seeing shares rising.
Why do stock prices fall?
To compensate, the price people are willing to pay will need to drop so that they will be rewarded after the effects of inflation are felt. This is why stock prices may initially fall when inflation increases. After the initial fall, however, the price of equities will increase with the price of everything else.
What would happen if the earnings increase was a certainty?
If the earnings increase were a certainty, this would happen, because ten times earnings is thought to be a fair price for the stock, assuming that everything else that could affect the stock price remained the same. There is uncertainty, however, in whether a company will actually meet those earnings. The greater the level of uncertainty, the ...
Is stock a long term investment?
As usual, stocks are a long-term investment. Over long periods of time, the chances of doing well with a diversified set of stocks is almost ensured. Over short periods of time, however, there are several factors, including inflation, that can result in a loss.
Do stocks rise with inflation?
With inflation, the prices of things generally increase. You would therefore expect the prices of stocks to rise as well. This is true during the latter stages of inflation, but initially equity prices may actually fall. Here’s why:
Will the price of equities increase after the initial fall?
After the initial fall, however, the price of equities will increase with the price of everything else. Businesses will pass the cost increases they see for materials and labor onto their customers who will pay for them with inflated dollars.
Fundamental Factors
Technical Factors
- 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 growthindirectly contributes to earnings growth. Technical factors include the following.
News
- While it is hard to quantify the impact of news or unexpected developments inside a company, industry, or the global economy, you can't argue that it does influence investor sentiment. The political situation, negotiations between countries or companies, product breakthroughs, mergers and acquisitions, and other unforeseen events can impact stocks and the stock market. Since s…
Market Sentiment
- Market sentiment refers to the psychology of market participants, individually and collectively. This is perhaps the most vexing category. Market sentiment is often subjective, biased, and obstinate. For example, you can make a solid judgment about a stock's future growth prospects, and the future may even confirm your projections, but in the meantime, the market may myopica…
The Bottom Line
- Different types of investors depend on different factors. Short-term investors and traders tend to incorporate and may even prioritize technical factors. Long-term investors prioritize fundamentals and recognize that technical factors play an important role. Investors who believe strongly in fundamentals can reconcile themselves to technical forces with the following popular argument…