A question that has plagued us investors for eons – what exactly moves the stock price, and how can we determine where the stock price will end up in an hour, a day, or a week’s time?
Well simply put, stock prices are determined in the marketplace – the price at any given moment is due to supply and demand.
But examining this in more detail, there are three pivotal factors which drive the stock price on a day-to-day basis.
- The fundamental factors
Fundamental analysis is the process of looking at a business at the most basic financial level. Some factors include: the company’s earnings and overall profitability. Some of these factors can take a longer time to come into play. For example: The adoption of electric vehicles may take longer vs. AfterPay, which became an overnight phenomenon in a short time span. Other valuation metrics include:
- The EPS (Earnings Per Share) which is the return on investment per unit of stock, or
- Valuation multiples such as EBITDA (Earnings Before Interest Tax Depreciation Amortisation) and P/E (Price to earnings) ratio, the price you are willing to pay for a future stream of earnings – think annuities.
- Technical factors
Are largely related to external conditions which shift the supply/demand of the stock. Some factors include:
- Inflation: Historically, low inflation drives high multiples and high inflation drives low multiples.
- Economic strength: Refers to the growth of the stock’s specific sector and also the overall market.
- Trends: short-term trend and the momentum of the stock price can affect demand. Much like trends on social media, people will jump on the trend without a second thought, increasing demand.
- Liquidity of the stock: How attractive is the stock from a liquidity perspective? More popular stocks are generally more attractive for high liquidity.
- News: Good news vs. bad news.
(Not to be confused with technical analysis which observes the trends in price/volume action)
- Lastly, we have the market sentiment.
This includes the feelings of the market participants about the stock, which is subjective based on the information each individual digests and how they interpret that information.
Now keeping in mind the above factors, we can look at the AfterPay stock price as an example. There was a huge surge in stock price when the company released its FY19 annual report. This was due to:
- Sales, income and customers increasing by a tremendous amount.
- CAGR (Compound annual growth rate) ~ 200%.
- Successful launches in the UK.
- Strong partnerships formed with a variety of brands and stores.
- Relative growth vs. ‘comparators’ being strong in US and UK markets.
Which ultimately led to an overall positive market sentiment, driven by strong growth prospects.
Alternatively, A2 Milk, the golden child of the ASX, was a measly 70 cent price per share 5 years ago, now sits at around 13 dollars. A mere 2000 dollar investment could pay off your entire HECs Debt (you could even fail BFC3540 a dozen times if you wanted to).
Unfortunately, A2 came out with a result just shy of market expectations. Despite the good performance in ANZ and Asia, the falling out of business in the U.K. and $44m EBITDA loss in the U.S came back to bite A2’s share price in the ass. When you’re a leading stock, you can’t afford to miss market expectations – this slight miss has resulted in a massive shift in sentiment, evidenced by the share price struggling to recover.
The movement of stock prices can be attributed to many factors, some of which cannot be predicted reliably. However, by examining these factors and doing a thorough analysis, the movement can be reliably anticipated.