Unlike most of the things we buy throughout our lives, the elements that go into the price of a stock are in many ways unique. In order to understand it all, it’s helpful to consider mankind’s early business endeavors.

Humans start businesses to make money—and the more, the better. One way to make more money is to expand the business. But opening another production facility or additional stores, or hiring more people costs money the owners often simply do not have. Centuries ago, a business owner who didn’t have the money needed to expand his business had one option—to go into debt by borrowing the needed money. At some point, someone somewhere got the brilliant idea to offer part ownership of the business in order to raise the needed money. An owner offered a share in the business at a price. A share today is the same thing that it was back then.

We can imagine that pricing then was probably the same as it is today. The price of a stock is made up of two factors—fundamentals and future expectations. In the modern world, many privately held businesses choose to “go public” through an Initial Public Offering (IPO). Investment banks are hired to assess the value of the company’s assets, its revenue and profits, its position in the market, and its prospects, all of which are published in an Investor Prospectus.

Based on their analysis, the investment banks recommend—to large institutional investors and high-net-worth individuals (rich people) with accounts at the investment banks—a range of initial offer prices for the stock available for purchase. The general public must wait to buy until the stock goes on sale on the open market.

The price of a stock is made up of both the fundamentals and future expectations. Fundamentals can include historical sales, profitability, market share, and assets (what the company owns). Future expectations include revenue growth and market share potential.

Where are stocks traded?

Today, stocks are traded on exchanges throughout the world. Arguably the most important is the U.S. New York Stock Exchange (NYSE). The U.S. NASDAQ (National Association of Securities Dealers) is the second-largest exchange in the world, and the largest in Europe is the London Stock Exchange (LON). An exchange is a market place for buyers and sellers, but the digital age has eliminated the need to go to an actual physical location to buy shares of a company. The process is similar to wholesaling in that most investors must purchase or sell through middlemen, known as stockbrokers.

Once an IPO offering starts to trade on an exchange, the share price begins to be influenced by expectations, or market sentiment. Global companies with brand recognition, such as Facebook or Twitter, can attract investors like flies to honey based solely on the belief that these companies will grow like wildfire.

However, one could also liken the often-overwhelming rush of buyers to moths attracted to a flame. Social psychologists are becoming increasingly interested in studying market behavior and have identified a phenomenon known as the herd mentality. Stock prices follow the basic laws of supply and demand. If a herd of investors begins galloping to brokers screaming “Buy! Buy! Buy!” the price of the shares will rise. The danger is that the price could be rising independent of the company’s real fundamentals and future prospects, and then it could swiftly begin to fall as fast as or faster than it rose.

The digital age has ushered in another factor that influences market sentiment—the lead-in from one region’s exchanges to another. If stocks on Asian exchanges are plunging when the exchanges in Europe open, professional investors will be looking over their shoulders and worrying about what’s happening in the Asia Pacific region. The process then moves to the U.S. exchanges, where investors consider what economic conditions and other factors may be driving both Asian and European stocks up or down. We live in an interconnected age.

Stocks are traded through intermediaries—stockbrokers—on exchanges across the world. While financial fundamentals play a role, stock prices are equally influenced by how the investment community perceives a company’s future. In an era when global economies are interconnected, the events in other regions can impact stock prices at home.

Stock price movement

Throughout your investing career you’ll read time and again that stock price movement is determined by supply and demand. When there are more buyers than sellers, the price goes up, and when sellers outnumber buyers the price goes down. True enough, but what influences demand? Why are large numbers of investors driving up the price of one company while ignoring another?

Four of the critical drivers of stock price movement are 1) company fundamentals, 2) economic and macro-economic conditions, 3) technical indicators, and 4) news. Many professional investors apply a variety of measures to determine the present and future value of a company. Techniques include ratio analysis wherein a company’s earnings, sales, and asset value are compared to the current share price. Discounted cash flow analysis is a complex process used by sophisticated investment professionals.

Regardless of the strength of a company’s fundamentals, local and global economic conditions can influence market sentiment and expectations. When unemployment is high, investors worry about the impact of diminishing demand on revenue and profits. Political unrest (such as the early 2014 crisis in Ukraine) can also influence stock prices. China has become a large buyer of global commodities and other goods and the potential of economic slowdowns there is an additional source of worry.

Some investors use technical indicators to determine entry (buy) and exit (sell) points. There are technical indicators based on historical price movements that many believe are better signs of upward and downward movements than fundamentals are.

Finally, there is news. News items can be company specific or general and they can have huge impacts. The news that a company’s new drug or medical treatment has received final regulatory approval for sale in the market, or that the treatment has progressed successfully from one phase of the regulatory process to another, can lead to a dramatic upward spike in the stock price. Companies often issue press releases warning the investing community that upcoming revenue or profit may fall short of expectations, activity which can cause the share price to drop, sometimes drastically.

What about the supply side of the economic law? In most cases, the company has issued enough stock to adequately meet demand, but that ignores the amount of available similar stocks. Investors interested in healthcare stocks surely want to consider the “best of breed.” Comparing companies can be difficult as not all companies offer similar products to similar markets, and companies come in varying sizes. Market capitalization is a way to ensure that you’re at least comparing companies of similar sizes. Financial websites include a stock’s Market Cap, which is calculated by multiplying the total number of shares outstanding by the current per-share price.

A company’s share price moves up or down based on the financial fundamentals of the company, changing expectations about its future revenue and profits, local economic news (both positive and negative), global economic news that could impact the company’s business, and technical indicators wherein the price of the shares fall into a predictable pattern based on historical price performance.

Bottom Line

The price of a given company’s shares is not fixed; rather, it ebbs and flows based on a variety of factors. One is the fundamental value of the company, as measured by financial indicators such as asset value, revenue, and earnings—that can be expressed in ratios comparing the fundamental factor to the share price. Others include current and future economic conditions, both local and global. General economic and financial news and company-related news also serve to move the share price up or down. Finally, technical analysis investors look for price levels that are based on historical performance to indicate buy and sell points for particular stocks, and often for the market as a whole.

Summary:

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The price of a stock is made up of both the fundamentals and future expectations. Fundamentals can include historical sales, profitability, market share, and assets (what the company owns). Future expectations include revenue growth and market share potential.

 

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Stocks are traded through intermediaries—stockbrokers—on exchanges across the world. While financial fundamentals play a role, stock prices are equally influenced by how the investment community perceives a company’s future. In an era when global economies are interconnected, the events in other regions can impact stock prices at home.

 

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A company’s share price moves up or down based on the financial fundamentals of the company, changing expectations about its future revenue and profits, local economic news (both positive and negative), global economic news that could impact the company’s business, and technical indicators wherein the price of the shares fall into a predictable pattern based on historical price performance.

  

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