You must have heard about the rise and fall of stock prices. If you are someone new to the market, stock prices might be mysterious to you. You might be wondering why do stock prices move up and down? Who decides the stock price? and what factors determine whether stock price will move up or down?
In this article, you will get answers to all of these questions. We will let you know 10 most important reasons why stock price increases and decreases in the stock market.
Once a company has raised capital from its investors, it gets listed in stock exchanges to allow those investors to buy and sell stocks among market participants.
There are too many factors that change the stock price such as earnings, the economy, credit market, personal sentiments of investors and geopolitical events.
One of the most important parameter investors look for in a company before investing in stock is it’s earnings. However, the overall company’s share price is determined entirely by supply and demand in the market.
What is Demand and Supply
In simple words, supply is the number of shares people want to sell and demand is the number of shares people want to buy. The difference between supply and demand decides in which direction the stock price will move.
That is to say, if a large number of market participants want to buy shares of a particular company and a lesser number of market participants are willing to sell, the share price would rise.
Likewise, if there are few buyers and more number of sellers in the market, the price would fall as there will be a fight among sellers as a result they will undercut each other’s price to sell their ownership.
In simple words, stock price movement depends on how many people are interested to buy versus how many want to sell it.
You can find out the demand and supply position of a stock by looking at the stock’s bid and asking prices range against the number of shares people want to buy and sell.
Investors buy shares of a company with a hope that the business will grow and will do well over time. When plenty of investors believe in a company’s growth, they show their willingness to buy the company’s share, which increases demand for the stock, due to which value of the share also increases. There can be times when the price of a stock does not reflect how well the company is doing.
Decision to buy or sell a stock depends on so many factors. In this article we will tell you 10 most important factors which increase or decrease share price in the stock market.
The first thing that comes to mind before investing is what is the earnings of the company?
Growth in company’s sales and earnings
Investors and traders try to find out the possible growth in earnings of the company in comparison to market leaders, industry and other major players. Remember, earnings are referred to as profit or bottom line.
Growth in earnings will decide whether share price will move up or down.
Now your question would be how to know what is growth in earnings?
Imagine, a company ABC Limited has total earnings of Rs 100, Rs 120 and Rs 144 for the last three years respectively. Would you invest? We know the answer, it depends on the investing strategy you follow.
In this case, company ABC Limited has had an earning growth of 20% for the last three years, which is not bad.
Investors say earnings drive the market. If there is no earning growth, then market participants may not take interest in buying.
Therefore, the first and foremost thing you should do is to find out what is the company’s earning growth and how it’s going to maintain it in future.
Earning growth also indicates that the management is managing the company well.
If a company reports low earnings for a few quarters, demand for buying the stock will fade and supply will rise. When there are more sellers willing to sell the stock than buyers willing to buy, this creates more supply than demand, due to which stock prices begin to fall.
At a point, when more market participants find the stock attractive at a price, they show their willingness to buy the stock as a result demand grows faster than supply, and the price moves up. It will stay at a point where there is a balance between demand and supply.
Increase in company’s book value
Book value of a company is calculated by taking out total liabilities out of total assets. Which means book value = total assets minus total liabilities.
Book value is also known as net worth of the company.
Assets is what the company owns.
Liability is what the company owes to outsiders. Therefore, debt is part of total liabilities.
Net worth or book value of the company goes up when there is an increase in assets and decrease in debt.
Best comparison to book value is the company’s market value.
Market value is the total market capitalization of the company. It goes up and down based on the demand and supply of company’s stock in the marketplace.
Market value can be high or lower than the book value.
When a company’s book value is more than the market value, it generally means that the stock is undervalued. On the contrary, if it’s less than the market value, then it is overvalued.
When a stock is undervalued, many value investors might take interest in buying the stock. On the other hand, value invested might be interested in selling a stock when its overvalued. Based on the decisions of theses value investors and institutional buying or selling, stock prices will move up or down.
However, you can’t base your investment decision on the basis of book value and market value comparison. It’s one of the factors. You have to assess the overall financial conditions and growth in earnings before investing.
Company insiders know the company very well than outsiders.
Insiders are the key managerial personnel such as company’s directors, CFO, COO and others. These people can buy stocks for themselves to grow their own personal portfolio.
When you see insiders buying a company’s stock in market data, it can be a positive sign. You need to dig deeper into the matter and if it’s a positive reason for buying, then you can invest.
Buying stocks by insiders reduces the number of stocks held by the general public, due to which, demand of the stock goes up and supply comes down. This resulted in the stock price higher.
Rumors – Takeover, acquisition and buyback
Rumors move the price higher as many market participants start buying on the basis of the news flashed before them. It attracts many market participants to buy the stocks.
They don’t try to know whether or not the news is real.
In such a case, you can consider buying only when the company has strong fundamentals, growth in earnings, popular branded products or services and good financial health.
Rating by credit rating agencies
Companies issue bonds to fund their business. In order to assess the creditworthiness of these companies, credit rating agencies from time to time publish their rating.
Please note, it’s not only relevant for those who have purchased bonds. As it’s the overall creditworthiness of the company, equity holders are also interested to act according to the rating.
Creditworthiness will tell you the financial worthiness of the company to repay its debt and interest back to bond holders.
Here are name of certain credit rating firms;
- Standard & Poor’s
- Credit Rating Information Services of India Limited (CRISIL)
- Investment Information and Credit Rating Agency of India (ICRA) Limited
Industry growth is one of the main criteria you should consider for investing.
If the industry is growing at 20% year to year, then investing in market leaders will help you to get that growth.
In case the industry is big and major players have pricing issues due to high cost, then investing in a small cap stock from that industry who can grow at 20% Year on Year due to price and marketing advantages can be a better bet.
Industry growth helps the company to grow. If we don’t have industry growth, then companies will struggle to survive.
Low P/E ratio compare to industry peers
We have already discussed what is Price to earnings or P/E ratio.
It’s the first number that investors look at before analysing or looking at some other number. It tells the market participants, the earning multiplication at which the stock is trading at present.
If a stock is trading at a low P/E ratio with good fundamentals compared to competitors from the same industry, then it’s a buy.
There can be so many other factors due to which share price increases in the stock market. Whatever be the reason, it all depends on demand and supply.
If demand for a particular stock exceeds the supply, price will rise. When there is more supply than demand, stock price stock prices begin to fall. Whatever intrinsic value you have calculated to be right for the stock to buy, its price will always depend on the demand and supply of the stock.
If you are lucky, you might get your favorite stock at or below the intrinsic value. In most of the cases, all blue chip stocks and fundamentally strong companies’ stocks are traded above the intrinsic value. If you can find a stock which is below the intrinsic value and has all the potential to give you a satisfactory return over a long period of time, then you are a perfect value investor. My best wishes are with you.
Profit booking by large institutional investors and FIIs
Large institutional investors based on their strategy may realign their portfolio or convert a certain portion of their stocks to cash.
For instance, if a mutual fund wants to convert 1% to 2% of a stock to cash in order to pay a dividend, then they book profit, which reflects in stock prices.
Foreign institutional investors or FIIs such as foreign banks, hedge funds, and insurance companies play a significant role in the stock market. They may sell their portfolio in case of weakness in the country’s economy or if they want to invest in some other country. Buying and selling of shares by these FIIs causes fluctuation in share prices as they buy and sell a massive amount of shares.
Market sentiment depends on the psychology of individuals, institutional investors, FIIs and others. You may have chosen the right stocks with your own research, but it wont move if investor or trader sentiment towards the market and stock is not there.
We have tons of traders who buy and sell stocks based on chart patterns. If the stock is trading at its resistance level, certain stock traders start selling. After reaching a point, known as the support level, stock starts trading at a bargain price and again traders buy at that level to make profit at a higher level. Therefore, support and resistance level in a technical chart plays a role in stock price movements, it has nothing to do with fundamentals.
When there is a high demand for the stock, with a limited supply, bidders have to compete with one another to get shares. If the interest in a stock is intense, more bidders are attracted to buy the share, and less number of stock owners are interested in selling, then due to higher bidding for the stock, price can skyrocket.
Bidders are attracted to a stock or market based on above factors.
If more number of market participants are not taking interest in the stock market or in a stock, then few bidders participate, and more number of sellers are interested in selling their stock, due to which price falls down.
Stock market is a place where you will learn new things everyday. If you are a beginner or new to the stock market, investing through mutual funds or a professional financial expert might be helpful. You can also start investing on your own with a little amount after creating an emergency fund for your survival, the choice is yours.
In addition to the disclaimer below, please note, this article is not intended to provide investing or trading advice. Trading in the stock market and in other securities entails varying degrees of risk, and can result in loss of capital. Most investors and traders lose money. Readers seeking to engage in trading and/or investing should seek out extensive education on the topic and help of professionals.