How is a stock price determined?

If you have been following happenings in the stock market, you will notice that there are variations in the stock prices of companies. In other words, their prices tend to differ. This is one subject matter that most stock investors can’t seem to understand. For instance, the price of Tesla share ranges from $600.00-$868.45, while that of NIO ranges from $39.28-$51.31.

Despite these two companies operating in the same industry (EV/automobile), you will notice that there is a vast difference in their share prices. Another example is the shares of e commerce giants, eBay and Amazon. So you must have noticed that while Amazon shares are priced at $2,977.57, that of eBay is $53.34. Again, this is another vast difference despite both companies operating in the same niche.

Company earnings

This has to be the first factor to be considered amongst others when it comes to how is a stock price determined. Companies that are publicly traded are always expected to submit official reports of their earnings 21days after every quarter. Investors usually have projections (anticipations) that need to be met. When such are not met, the stock price is expected to reduce and vice versa.

When companies are showing improvement in earnings and cash flows, it means expectations of investors are being met. In this case, investors will be willing to pay a premium amount for such shares. It is a sign that the company is performing well and ready to compete. On the other hand, stock prices are bound to reduce drastically when companies perform below expectations as shown in their reports.

In this case, the natural law of demand and supply will come into play. For instance, when a company is performing very well, there will be too many investors going after its shares. This will eventually increase its price. As more shares are being issued to raise additional capital, the prices will be rising. On the other hand, poor performances means some investors may likely sell their shares. This will bring down the share price to a great extent. Therefore, one of the most obvious factors that can influence the stock of a company is how it has performed over a given period of time.

The bid and the ask price

When a company decides to make its shares available to potential investors, there is always a price tag attached. This is known as the asking price. It is that price which the company is willing to sell its shares. Potential investors or buyers on the other hand, will then announce the price that they are willing to pay for such shares. The bid is what this price is called. The trade has to be facilitated between both the company and such potential buyers. This is a role played by market makers.

The stock price of a company is determined by ask and bid. In this instance, the trade is going to be executed when both parties come together (sellers and buyers) and reach an agreement. When trade occurs, the price at which it has taken place officially becomes the company’s stock price. This strategy is mostly used by companies that are just getting started in the aspect of raising capital through selling of shares. As time goes on, other factors are going to strongly determine how its stock price will be sold to members of the public. 

When it comes to who dictates the price more between sellers and buyers, many factors usually come into play. For instance, if the company has an idea that will make it become a leader of its industry in the nearest future, it will be in a much better position to dictate the price of such stock. This is very obvious in the automobile industry where electric vehicles seem to be making headlines.

On the other hand, a company without any innovative idea will not be in a very good position to negotiate its stock price with potential buyers/investors. This is because it is not giving investors any impression that it can compete favorably with the heavyweights in its niche or industry.

News and rumors

Do you know that rumors and news can influence the market price of a company’s stock to a great extent? Of course, news in this instance can be positive or negative. It is the reason why companies are bent on ensuring negative reports about their activities never get to the knowledge of members of the public. These are capable of influencing their share prices. When a company is reported to be making moves that will shake its industry that will always sound like good news to members of the public. Investors in such cases will be thinking about how to cash out from such innovation.

On the other hand, negative reports will reduce a company’s stock price. For instance, if a company is having legal issues to sort out which threaten its existence, this will likely affect its stock price in a negative way. Another example is corporate scandals. Facebook is one of such companies. In the month of July 2018, it finished with $131.55. According to experts, this was the least closing price it had experienced in the last 22months. 2018 was a year of various scandals which affected the company’s market cap to a great extent.

Another example of corporate scandal is that experienced by Lehman Brothers in 2008 when it was discovered that outstanding loan of the company was far more than its capital. It was a problem which led the company to file for bankruptcy. According to reports, over 70% of its value was wiped out. This crisis made the company go extinct. Its stock reduced by a whopping 93%. It may shock to know that such reduction in share price happened within 72hours.

Another thing to have in mind when investing or trading is the saying “Buy the rumor, sell the news”. The stock market isn’t always rational, so the price can go up only based on speculation. After that when the actual news comes out, the price can suddenly drop.

Valuation multiple

How a company is valued in its industry is another factor that gives indication about how is a stock price determined. There are two major factors that can be taken into consideration in this regard. These are the expected growth rate and the discount rate. It is through the discount rate that a company’s future present value is computed. It is quite simple to understand as a company with a positive growth rate will experience an increase in its stock price over the course of time.

Investors like taking part in companies that have potential to grow. This is especially true when the industry is still young and untapped. They are always optimistic about making reasonable profits from their investments. During the early 90s, the video game market showed lots of promises with brands like Nintendo, and Sega coming up with different innovations.

Investors were able to project that it was a niche which would get better in the next few years. You can bet that they were very correct because the video game market is currently worth billions of dollars.

Economic factors

In case you don’t know, economic factors are one of the most obvious determinants of stock prices. A typical example is inflation and deflation. Inflation is experienced when the prices of goods and services are increasing. According to experts, low rates of inflation can help a company sell its stocks much faster. However, investors are very reluctant to purchase shares when the rate of inflation is high. 

This is because they are of the opinion that the company is not doing well. A situation like this can bring about a reduction in the price of stock. Deflation can also discourage investors from buying stock. It gives them the impression that the economy is weak. Just like high inflation, the prices of stock will reduce drastically in most cases.

Another factor is interest rates. When such rates increase, it means that borrowing money has become very expensive. Once there is a rise in the interest rate (of the Federal Reserve Board), companies usually come up with strategies like laying off workers, and reduction of spending. Developments like these don’t encourage investors thereby leading to reduction in stock price.

Final words

Having said the above, it can be seen that there are various factors to be considered when it comes to determinants of a company’s stock price. The details of this post have been able to explain the major variables to enable you to invest wisely in the stock of a company. If you enjoyed the article and want to learn more about the stock market, have a look at our stock market guides.