June 11, 2013 By admin

What Does the Share Price of a Stock Tell us?

The price action of a stock is simply caused by supply and demand for that companies stock. The price of a stock should reflect an investors expectations in the long-term. Its important not to equate a companys value with its share price.

The value of a company, also called market cap, is calculated by:

Stock Price x No. of Share Outstanding.

Comparing the share price of two companies is meaningless.

For e.g. a company  that trades at $5 per share and has 5,000 outstanding shares has a lesser value than a company that trades at $40 that has 1,000 shares outstanding.

What Affects the Price of a Stock?

1. The supply and demand demand and supply in the marketplace determines stock price.If more people want to buy (demand) than sell (supply), the shortage drives the price up. If more people want to sell a stock than buy, surplus will drive the price down.Demand is affected by investors present and future opinion of valuations.

2. Earnings Earnings are a major driving force affecting investors valuation of a company. Earnings are the profit of a company makes without which no company can survive long term.Companies are required to report their earnings quarterly. Investors base their future value of a company on earnings projections.

3. Valuation In addition to earnings, investors sentiments, attitudes and expectations ultimately impact stock prices. Analysts use valuation methods to predict future market prices to profit form price movement. Stocks that are deemed undervalued are purchased. Stocks that are deemed overvalued are sold, it is anticipated that undervalued stocks will rise in value, while overvalued stocks drop in value.

How do Investors Value Stocks

There are 4 basic factors

1. Price to Book Ratio = Share Price / Book Value of a Stock. Value of a company if it is torn up and sold today. Value should be low. A lower p/b ratio could mean that stock is undervalued or more realistically priced.

2. Price to Earnings Ratio = Share Price / Earnings Per Share. How much investors are willing to pay per $ of earnings.  A higher value is what traders want. A High P/E Ratio is a clear sign that investors forecast strong, consistent earnings growth in the future.

3. PEG Ratio = P/E Ratio / Annual Growth Rate. Stocks value while taking the companys earning growth into account. A low value is better. A lower PEG implies that you are paying less for earnings growth.

4. Dividend Yield  = Annual Dividend Per Share Price / Share Price. How much cash  you are getting for each dollar invested. Looking for a high number here. High and stable dividend yields  results in a paycheck even when prices drop.

Conclusion: The one thing we do know for sure is that the stock market can be volatile and this volatility creates opportunity.

Stock price movement echoes an investors ;

• Current sentiment
• Judgement of the value of a stock in the present and future.

There are various theories / studies done explaining the way a stocks prices move but not one of them explains everything.

Also no single valuation method (as mentioned above) can stand alone act as a measure of a stocks value. Using a combination of valuation methods, they provides investors with ways of looking at the real value of a stock.