Despite the record high number of investors in the stock market today, driven in part by the flood of retail investors, there are still plenty of confusion on what does stock price mean for a company when it comes to investing. This article explains all you need to know about stock prices.
What does stock price mean for a company?
Stock price (share price) tells you how much a share is worth currently in the market. By multiplying the stock price with the total shares outstanding, you arrived at the market cap, or the market value of the company. In other words, stock price is a market indicator of how much the market thinks that company is worth.
Why do companies care about their stock prices?
Companies care about their stock prices for a few reasons.
From time to time, companies may require capital infusion. Capital raised can be use for acquisitions, new growth plans, debt repayments etc. Generally, a healthy stock price can present an attractive opportunity for investors. For this reason, a healthy stock price allows for a less intricate capital raising process for the company.
Furthermore, from a creditor’s point of view, companies with a higher-priced stocks are generally viewed more favorable. This is in part due to higher stock prices being positively correlated with higher earnings capability. Hence, its ability to repay debt. Companies with healthy stock fundamentals also tend to attract lower interest rate on its debt, comparatively.
Most companies have vested stock options as part of its senior management team’s remuneration schemes. Usually, companies will further require a certain hurdle rate for its total stock price return with the aim to continue to incentivize its management team. Hence, aligning the companies’ incentive with that of shareholders'.
What does the stock price say about a company?
Warren Buffett once said “Price is what you pay and value is what you get”. In this context, stock prices are determined by the market, which can vary from its value. Since value are subjective to different investors, this is what creates a market.
How are stock prices set?
A stock price alone says very little about a company. In this case, the market cap of a company can be much more informative. This is the stock price multiply by the number of shares outstanding.
Understanding stock prices and value
Share price are set by market participants. These includes institutional investors, retail investors, market makers etc. The share price shown on your screens are the “last traded” stock price. In other words, this is the price where the buying price meets the selling price.
Main factors affecting share prices
In short, stock prices are influenced by the laws of supply and demand. Broadly, there are 3 school of thoughts that can explain why stock prices are what they are today.
- Fundamental analysis. This concerns company fundamentals such as quality of earnings, revenue growth and dividend etc. Naturally, the market will reward higher share price for companies that are expected to deliver. Here's an example of fundamental analysis.
- Technical analysis. This is a method where market participants analyse and forecast stock prices based on historical stock prices. In general, technical analysis are more prevalent in commodities and FX. Nonetheless, it remains one of the main factors affecting stock prices.
- Quantitative analysis. This involves techniques that uses mathematical modeling and research to understand stock price behaviors. Subsequently, models are designed to operate as an automated trading system.
Macroeconomic factors affecting share prices
In addition to micro factors mentioned above, here are a few key macroeconomic factors affecting the stock market you should be aware.
Interest rates are often cited the one of key macroeconomic factors affecting the stock market. Theoretically, a lower interest rates means that two things broadly. First, interest accrued in your savings account becomes less attractive. Second, borrowing cost are now lower.
For these reasons, a lower interest rate often lead to consumer spending more as things are now more affordable relatively. Eventually, this leads to higher sales growth and profitability for businesses, as a result. In turn, this is reflected via higher stock prices. The opposite is true.
Next, inflation can cause stock prices to decline. This is the effect of sustained increases in prices of general goods and services over time. Consequently, consumers’ purchasing power are reduced given the heightened prices. Hence, leading to lower growth for companies and stock prices. The converse is also true.
The world economy has become increasingly interdependent, it’s rare for a company not to be expose to foreign exchange (FX). For example, Tesla sources majority of its car parts internationally. Given that Tesla is US-based, a strengthening in US Dollars ($1 can now buy more relative to other currencies) may reduced its cost/expense base. Thus, potentially leading to higher profitability and stock prices.
The key points of the article are:
- Stock price is a market indicator of the company’s share and hence, the company’s value.
- Solely looking at the stock price may prevent investors from understanding the full picture. Looking at the market cap may provide some context in this case.
- Stock prices are market driven, whereas value is subjective. This is what creates a market.
- Stock prices are set by buyer and sellers. Technically, the “last transacted” share price is the price where the buying (bidding) price meets the selling (asking) price.
- In addition to the laws of supply and demand in the market, share prices movement can be explained by fundamental, technical and quantitative analysis.
- Interest rates, inflation and FX are one of the key macroeconomic factors affecting the stock market.