Five Factors that Determine if a Stock Price Rises or Falls
When the market seems to be completely removed from reality, what determines stock price? What are the factors you can watch to know where stock prices are going?
In this video, I’ll not only show you how stock prices are calculated but five forces you can watch to know where those prices are going.
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What Goes into the Price of a Stock?
Nation, we see a lot of great questions in our private Facebook group Let’s Talk Money Together and one of the most common is simply What Determines Stock Price?
And there’s actually a lot more in that question than you might think. It’s more than just the basics of how a stock price is calculated but the factors that go into changes in the stock price. Even more important, it’s how to determine the fair value for a stock price.
So that’s what I want to do with this video, show you not only what determines stock prices but the five factors you need to watch if you want to know where that stock price is going. I’ll also reveal a few ways to calculate a fair stock price on your investments.
What Does the Stock Price Mean?
So at it’s most basic, a stock price is just the market value of a company spread across all the shares outstanding. Stocks are an ownership of the company so it’s whatever investors are willing to pay spread across how many investor shares there are.
Let’s look at an example here with Apple, ticker AAPl. We see here the market capitalization, that’s the value investors are willing to pay for the company, is about $1.31 trillion. Now we can find how many shares, or pieces of ownership, in the statistics tab on Yahoo Finance or on just about any investing platform. We know that Apple has about 4.33 billion shares available; so that $1.31 trillion company value divided by 4.33 billion gives us the share price around $302 per share.
What’s interesting here is that you realize, stock price has very little to do with whether it’s a good investment or not. A lot of investors will look for stocks under $5 a share thinking it’s a bargain-basement deal. Or they’ll think a high stock price means it’s a strong company.
For example, regional bank Mars Bancorp, has a $340 share price which seems really strong, right? But the shares are down more than 12% this year and the company is really only valued at $27 million. The high share price is only because it has less than 100,000 shares issued.
By comparison, look at Zynga, ticker ZNGA, with a price of under $8 per share. It’s jumped 34% over the last year and is valued at $7.6 billion. The reason the stock price is so low is simply a matter of almost a billion shares issued.
How to Find the Fair Value for a Stock
So instead of looking for “low-price stocks” or thinking that a high stock price is good, let’s look at five factors that causes a stock’s price to rise or fall and how to determine a fair value.
The first factor is going to be a change in the company’s earnings or net income. Every company reports its earnings four times a year, at the end of its quarter, and the market follows every word of these announcements.
Since stocks are an ownership of the company, the stock price is a direct reflection of how much of those earnings you own and whether they’re going up or down.
And we’ll use the Analysis tab here in Yahoo Finance to look at earnings but you can find this on any investing platform. Personally, I use my Webull account because it shows you the earnings dates for each company as well as some other information but I want to use Yahoo here because it’s easily accessible for everyone.
So the first thing you see here is that 36 analysts have an average estimate for Apple to make $12.32 in earnings for the current year. You can see the high and low estimate as well as what earnings were last year.
This gives you an idea of value in the shares as well. If Apple stock is trading at $301 per share and the company is expected to produce $12.32 per share in earnings, then investors are willing to pay a price of 24-times those earnings.
What you can do with this Price-to-Earnings ratio, is compare it against other companies like Microsoft to see which company is trading inexpensively, or you can compare it against Apple’s own PE history. So if Apple has traded at a price of 15-times earnings in the past, we can say that now at 24-times, it’s relatively expensive.
Now what you’ll see in all these factors is it’s not so much where they’re at right now because that’s already priced into the stock. The market knows how much Apple is producing in earnings. What’s important to whether the stock price goes up or down is how these factors develop in the future.
That’s where it takes some analysis and it’s why most Wall Street analysts only follow a handful of stocks. You need to follow these five factors for each of your stocks, understand the direction they’re heading and develop your own opinion for the future.
For example, if we go to the Analysis tab again on Yahoo for shares of Apple. We can see earnings history over the last four quarters including that surprise percentage, so how much Apple has beaten analyst estimates for earnings.
Now your job would be to take everything you know about Apple and the rest of the four factors we’ll talk about, and decide whether you think earnings will surprise to the upside by more than they have in the past.
Financial Indicators for Stock Price
Just like we looked at earnings, there are other financial indicators I like to follow for each stock I buy.
Here you’re looking into a company’s financial statements for measures that will feed into that earnings number because that’s really what it’s about. All you in the Bow Tie Nation know that my favorite measure is the operating margin, that measure of how well management turns sales into operating profits, but in reality, it’s just a step towards those bottom-line earnings. It gives us a clue into the profitability of a company compared to peers and what direction those earnings are heading.
So I want to highlight a few of the financial indicators you can use to follow a stock and determine a fair value. I’m only going to highlight two measures here because I don’t want to bog you down with a huge list but you can use these ideas to compare any of the financials.
First is the operating margin and you can find it here in the Statistics tab on Yahoo or just divide the operating income by the total revenue, and both those numbers are on the company’s income statement.
That operating margin or profitability shows you how well management is converting sales into operational profits, so the sales minus all operating costs.
We’ll also use the Return on Assets of the company and this is also shown on Yahoo Finance or you take a company’s net income, that’s the earnings from the Income Statement, and you divide by the company’s total assets which is found on the balance sheet.
Technically you’re supposed to use the average of the last two year’s total assets for this but we’re not going to get into the minutiae.
Just like the earnings, there are a couple of ways to use these numbers to determine stock price changes. First, you can compare them against the same measures at competitors. Is management at Samsung able to produce a higher return on assets or operating margin compared to Apple. Knowing this gives you an idea of financial strength and which stock might do better.
You can also follow the trends in these measures, so is Apple getting more profitable with a higher operating margin or is it getting less profitable and why?
How do Insiders Affect Stock Price?
Another factor you can follow is the insider and institutional buying in a stock.
Any big money player, so we’re talking institutions like Vanguard and hedge funds like Carl Icahn’s, is required to disclose their stock ownership with the SEC in form 13F each quarter. Company insiders, so management and board members, also have to report how much stock they buy or sell.
This is important because it not only gives you an idea of demand for the shares but also an insight into whether management thinks the shares are a good price.
You can either follow these numbers through market data, so here we see in the Holders tab on Yahoo, you see the institutional owners as well as how much of the company stock is held by these big money players, then on this insider roster section, you can see directors and management as well as their stock trades.
Or you can also use the EDGAR database on the SEC website to find the actual filings of these insiders and institutional buyers.
Either way, you’re again looking for those trends and big changes in these holdings. So if a hedge fund is increasing or decreasing its position or if insiders are buying up the shares. These trends can give you a very good idea of fair value on the shares and whether these investors think it’s a good deal.
Our next factor, and this is one of my favorite, is following the industry and economic trends for a company.
Now I know we’re getting a little vague here but remember, just about everything we know about a company is already baked into the stock price. The fact that Apple has an operating margin more than double that of Samsung but trades at a higher PE ratio, everyone already knows that. You’ve got millions of investors poring over earnings and financial statements.
So if all the current information is already known and in the price, the only way to determine where a stock price will go in the future is by having an educated idea of where these factors are going.
That means following the trends in the company’s industry and the broader economic trends affecting it. For Apple, how fast are input costs for semiconductor chips and other materials rising? What’s the outlook for wages and consumer spending over the next year?
In fact, some would say that a lot of this forward looking information is already factored into stock prices as well. Those millions of investors are looking at those trends and the saying goes that the stock market is forward-looking, factoring in earnings for the next six months.
This one’s a harder sale though and I do think you can make higher returns by understanding these trends better and making better estimates versus the rest of the market. If we look back at that earnings history, we can see that even the Wall Street analysts were wrong by as much as 12% when it came to predicting Apple earnings.
Again though, this is why most analysts only follow a few individual stocks or an industry. You need to spend the time to keep updated on the industry trends and how the economy is affecting your stocks.
How Does News Affect Stock Price?
Our next factor determining stock prices is news headlines around a company.
Here I’m not saying you need to predict the future and know when news is going to break about a company. You should be following the major headlines though and use them along with these other factors to determine, how it’s all going to affect the shares.
Some of these you can get in front of like if a company is expecting a lawsuit to wrap up soon, you can make your own guess on the outcome and trade in front of the news. Other news that comes as a surprise, you can use everything you know about the company to determine if the market is over- or under-reacting to the headlines.
It’s not an exact science but then if it were, every investor could just plug in the numbers and nobody could ever have an advantage. Follow the factors though, really learn how to use them, and you’ll be able to determine the fair value of stock prices before the rest of the market.