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Who Sets a Stock's Price?
There are
many, many factors that affect the price of a share but
basically it is determined by how much somebody is willing to
pay for it.
Perceived Value Just like any other auction, the price is determined
by the perceived value of the item being traded. It cannot
be calculated or determined by a formula. A good example is
that house prices fluctuate on a daily basis even though the actual
houses are not physically changing.
Biggest Factor - Earnings Probably the biggest factor in determining
the price is the company's earnings (profits), both now
and future projected earnings. Each quarter, every publicly-traded company is
supposed to publish its projected earnings
per share for that quarter. At the same time, market analysts
publish their predictions for many of those companies.
If the company falls short of their own projections or the analysts'
predictions, the price will often fall five percent or more.
That is because the price before the actual earnings announcement was made was
based on estimates that turned out to be
inaccurate. On the other hand, if a company announces projections
of much larger earnings than investors were expecting, the price would probably
go up because the future perceived
value would then be higher.
Intra-Day Factors Many stock prices fluctuate one to five percent
throughout a trading day. Is this because the company's real
value is changing that much throughout the day? Probably not. These fluctuations
are mainly due to factors outside the company,
including: - What the market is doing today (up, down, etc.)
- Other stocks in the same industry - World news, such as oil
prices and terrorist attacks - Day traders trading large quantities
of shares and affecting the price Although these factors
may not be related to the actual company, they have a very
real impact on the price.
Long-Term Factors The biggest long-term factors have to do with the
company's actual financial performance. Therefore, the long-term
price should reflect what the company is actually worth.
Here is a partial list of these factors: - Earning now - Earnings
for future quarters - Prospects for new business - Amount
of debt - Competitors
The Price is Wrong It is quite common for a stock price to be significantly
higher or lower than it is really worth. This can be
due to external factors, such as what the overall market or economy is doing, or
it could be a temporary overreaction by investors
due to rumors about the company, whether they are true or
not. In these cases, it could be said that the price is "wrong," and that
creates an excellent trading opportunity.
A great example of overreaction would be like when Apple announces
a great new gadget and thousands of investors go load up
on APPL shares. This creates a supply and demand issue where there
is not enough supply to meet the demand of the buyers, so naturally
the price will go higher and higher. The actual value of
the company should actually increase because their sales will go
up thanks to this new gadget, but the share prices may temporarily exceed the
actual value of the company due to this buying
frenzy. Again, that can create a great trading opportunity.
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