Does a drop in the stock price reflect the value of the company or their profit levels or speculation of unregulated investors?
There are four things that affect the constantly changing price of an equity: internal events, external events, market pressure, and hype. Let's take a look at these:
1. Internal events. These are events that occur within the company that affects the company's fundamentals, either directly or indirectly. Examples of internal events would be the release of quarterly financials that are either positive or negative, the signing of a large new client, the imprisoning of the company's CEO, FDA approval of a new drug, or the release of an innovative new product. With the announcement of a major new client for example, one can logically deduce that additional profits are imminent, the company's sales department is doing a good job, and its products are worthwhile enough to gain the attention of this large client. From that, more investors will come to think that this particular company is a good bet, buy more stock, and drive up the price. One of the most important metrics to look at in this category is the quarterly earnings per share (EPS), and whether it met, exceeded, or didn't meet previous expectations.
2. External events. These are major political, economic and social events that occur in the world that indirectly affect the company and its industry. For example, the Federal Reserve Board may raise the interest rate, a major hurricane may hit part of the country, or a politician that is unfriendly to the company's particular sector may get elected. These external events don't really directly affect the company's fundamentals, but they do nonetheless affect the stock price. The 9/11 disaster is a perfect example. After such a catastrophe, the entire country tends to be less willing to take risks, and go into a "hunker down" mode. Investors will put less money into higher-risk stocks, and either buy only mainstream stable investment-grade stocks or none at all. The entire market suffers.
3. Market pressure. A third factor is the market itself. While a stock may rise and fall on its own merits, it may also benefit just by being in a "bull market." If more people are investing in stocks in general, and the major indexes are rising, a stock that might otherwise be lackluster will enjoy something of a tailcoat effect. That's why it is always important to not only watch the movements of your stocks, but of the major indexes as well.
4. Hype. There are those who promote stocks for gain, either to pump up the price of their own shares or to promote them directly for a fee from the company. Such hype may take the form of positive reports in stock market newsletters, Internet chatter on bulletin boards, press releases and news reports. Despite how one feels about those who hype stocks, the hype must still be listened to. Even hype that has no foundation in truth may cause a short-term spike in stock price. A company's own public relations department may also have a major impact, and a good company will keep their name in the public's eye. All other things being equal, you will have better success investing in a company that issues press releases on a regular basis and seeks out mentions in the press, than you would investing in a company that issues a press release once a year and seldom gets mentioned in the press.
Previous Topic
Index