As a new investor, there’s a good chance you’re keeping tabs on how company share prices rise and fall all day. After all, share prices ultimately determine:
- when and how you invest in a company, and
- the returns on your investments.
But have you ever wondered why share prices rise and fall so frequently in the first place? Or how the share price is calculated? Then, we have just the right resource for you.
Read this blog to learn about share price calculations and how share prices are determined.
How are stock prices determined?
Company stocks or shares are usually up for trading in the share market. Sellers quote the price at which they will sell the stock, and buyers quote a price at which they will buy it. The stock gets traded only if both parties agree. So, if a buyer offers a higher price, the sellers catch onto it, and the price of a particular stock rises. What determines the buyer’s offer? The answer is simple – it all comes down to demand and supply.
If more buyers compete to buy the stocks for the same company (high demand), the stock price will rise. But if the company isn’t performing well and the sellers are keen on selling their stocks (high supply), the prices will fall.
Now that you have the answer to ‘how are stock prices determined?’, let’s move on to the next question: what factors influence the demand and supply of stocks?
1. The attractiveness of the industry
Buyers will only invest in company stocks if they believe they can earn returns from them in the future. Naturally, companies in industries that are likely to grow in the future will have higher share prices. The calculation of these share prices also depends on the following factors.
- Are new competitors entering the industry often?
- Is there scope for growth of the industry in the future?
- Do the customers or suppliers have any bargaining power?
2. Company performance
The next thing buyers check is the company’s performance. They will check the business model, the management’s quality, the company’s liquidity (determined by cash flow, profit margins, and annual revenues), etc. The better the performance of a company in a given sector, the higher the value of its stocks.
3. Change in management
Often a change in management can also raise stock prices. This happens when the new administration is more capable of furthering company goals or when they implement new policies that change the company product’s value.
4. Policy changes
Government policies impact how share prices are calculated by altering the demand for the stocks. For instance, if the Government announces the release of a new tranche of gold bonds, more people will buy gold, and the gold stocks might react positively. Similarly, when the RBI announces a repo rate hike, the stock prices usually fall.
5. Political scenarios
Political scenarios alter how share prices are calculated when they cause economic changes that affect business and retail investors. For instance, the Russia-Ukraine war introduced volatility into local and global markets. In March, Indian stock market investors lost over Rs. 6 lakh crores due to the market effects of the Russia-Ukraine conflict. Additionally, if the ruling party changes and introduces new economic policies, stock prices could shift too.
6. Natural disasters
Investors typically panic when natural disasters strike and start selling their shares en-masse. While this initially causes a market crash, the market eventually moves to price correction, causing the stock prices to shift.
Now that you know about how stock prices are determined, you might think share price calculation is impossible, given that it’s difficult to predict the fluctuations of the stock market. But there’s still a way to calculate the value of stocks right before you trade them. Here’s how.
How a share’s price is calculated
First, you need to gauge the share price in the market. One way to do this is to simply take the last updated value of the company share and multiply that with the number of outstanding shares.
The other way tocalculate the value of the stock is using the price-to-earnings ratio (P/E).
P/E ratio = The intrinsic stock price/Earning per share
The higher the P/E ratio of a company’s stocks, the better the chances of its growth in the future. That said, remember that most growing companies have a higher P/E ratio compared to established companies.
Stock prices shift due to both short-term and long-term regulators. While there’s no telling how much short-term regulators like policy changes, natural calamities, etc., might affect stock prices, keeping track of long-term market trends can help you decide where to invest. Before you put your money in a company’s stocks, don’t forget to calculate the value of the stock and compare it to its competitors.
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