Stock prices tend to be determined in the marketplace, where the seller supply meets buyer demand. As Kavan Choksi / カヴァン・ チョクシ says, there can be a myriad of forces that move a stock up or down. These forces are typically divided into three categories, fundamental factors, technical factors, and market sentiment.
Kavan Choksi / カヴァン・ チョクシ discusses a few of the major forces that move stock prices
Stock prices are primarily determined by fundamentals in an efficient market. These fundamentals would ideally refer to a combination of two things on a basic level, which includes an earnings base such as earnings per share (EPS) and a valuation multiple like a P/E ratio. An owner of common stock has a claim on earnings. On the other hand, earnings per share (EPS) is the owner’s return on their investment. As a person invests in a stock, they typically would be buying a proportional share of an entire future stream of earnings. This is the reason for the valuation multiple, it is the price one is willing to pay for the future stream of earnings.
A portion of the earnings can be distributed as dividends, while the remaining sum shall be retained by the company for reinvestment. People typically consider the future earnings stream as a function of the current level of earnings, as well as the expected growth in this earnings base.
The valuation multiple is meant to express expectations in relation to the future, and is fundamentally based on the discounted present value of the future earnings stream. The two key factors here are:
- The expected growth in the earnings base
- The discount rate that is used to calculate the present value of the future stream of earnings
A higher growth rate shall invariably earn the stock a higher multiple, however, a higher discount rate will earn a lower multiple. The discount rate is a function of perceived risk. A riskier stock earns a greater discount rate, which ultimately earns a lower multiple. It also is a function of inflation. Higher inflation earns a higher discount rate, which earns a lower multiple.
As Kavan Choksi / カヴァン・ チョクシ says, things would be a lot simple if just fundamental factors set stock prices. Technical factors in the mix complicate things. These factors involve external conditions that alter the supply of and demand for a stock of a company. Many of them indirectly impact fundamentals. For instance, economic growth indirectly contributes to earnings growth.
Company stocks often move in line with the overall market and their specific sector or industry peers. Prominent investment firms suggest that the movement of a stock is primarily influenced by broader market and sector trends rather than the company’s individual performance. Research indicates that up to 90% of the movement of a stock can be attributed to economic and market factors. For instance, if one retail stock experiences a negative outlook, it can lead to a decline in demand across the entire retail sector, pulling down other stocks in the same industry due to “guilt by association.”
