by Tom Doan
Throughout the Trade Month, I get many phone calls from clients asking why one of their positions has increased or decreased dramatically in price. Stock prices reflect a company’s current value as well as a projection of the future. Since the projection of the future is constantly changing as each day passes, stock prices are always fluctuating. To understand why a particular position moves dramatically, we first have to see why stock prices move in general; supply and demand.
Fundamentally, supply and demand influence stock prices just like any other marketplace. When demand is greater than the supply, the price increases and vice versa. So when investors are willing to buy more shares of a stock than other investors are willing to sell, the price will go up because of the limited supply. The concept of supply and demand is easy to understand, but how is it determined?
Since the stock price is a projection of a company in the future, earnings reports and news within the company play a large role in helping investors determine the value of a stock. Analysts predict a company’s earnings to determine a fair value price. When a company releases actual earnings that disappoint compared to expectations, the stock price falls because lower actual earnings means slower company growth and lower projected future earnings. The company may also release news that may increase or decrease investor’s projected value of a company such as a merger with another company or a CEO resigning. But how are the projections determined?
This introduces the Homo Sapiens. Each person has their own set of beliefs, attitude, and personality. Also in the equation are what makes people different from most species: emotions. One investor can be very optimistic and predict a company will grow by 20% the next quarter while a pessimistic investor can look at the very same information and project something entirely different. When optimistic investor projects a stock to be worth more than it currently is and pessimistic investor projects it to be worth less, the optimistic investor will buy shares from the pessimistic investor at an agreed price.
How each investor values a company is different because there are many different factors we would have to project such as earnings, future taxes, interest rates, and the entire global economy among a multitude of other factors. How much will company XYZ make in 2023? What will interest rates be ten years from now? The answer you get depends on the person you talk to and their answer will be influenced on how they feel about the current state of the economy and its future. The saying “your guess is as good as mine” hold true in this case. All of these factors and feelings are incorporated into valuations, essentially trying to predict a future that ’s unpredictable; this causes different valuations and is ultimately what drives supply and demand.
If the investors who are pessimistic want to sell more shares than amount of shares investors who are optimistic and want to buy, then the price will go down because of the higher supply and lower demand. When this happens on a large scale and many pessimistic investors look to dump their shares to only a handful of optimistic buyers, stock prices can be reduced dramatically because of the bloated supply and vice versa.
Although stock price movements do not change the way we trade, it is still important for us to know why stock prices move so we can understand it when a dramatic change occurs in one our positions. With the Snider Investment Method, we implement a series of safeguards and rules to use a systematic form of investing. This systematic form of investing allows us to continue trading each month without having greed, fear, market conditions, or stock price movements influence our decision making. We don’t try to predict what will happen to our positions in the future because unless you’re Marty McFly, the future will always be unpredictable.
