Fundamentals of Stock Price Movements

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Fundamentals of Stock Price Movements

Posted on 22 July 2011

Market demand and supply determine the stock prices. It is unfortunate that we have no standard to determine the stock prices behavior. There are some certain factors that move the stocks prices up and down. Let’s consider them one by one.

Analyzing Fundamental Factors

Fundamentals determine the stock prices. It comprises of earnings base i.e. Earnings per Share (EPS) and valuation multiple i.e. Price Earning Ratio. Individuals owning common stock can have residual claim on company’s earnings. EPS measure the return earned on investments.

If you buy a stock it means you have a significant share on future earnings stream and cause behind Valuation multiple. Valuation multiple refers to a price that is gladly paid for future earnings.

These earnings are distributed in the form of dividends and remaining portion of earnings is reinvested into business. Current level of earnings and expected growth of earnings can be viewed as a function for future earnings stream.

Earnings Base Analysis

There are different ways to measure earnings power i.e. measure based on cash flow, free cash flow per share. It also depends on the type of company that is analyzed. Different companies have customized their own measures i.e. funds from operations. Dividends per share is commonly use by mot companies. It shows what is actually received by shareholders.

Considerations About Valuation Multiple

Future expectations are expressed by valuation multiple and it is based on Net present value of future cash flows. Higher multiple is earned by higher growth rates and low multiple is earned by higher discount rate.

Discount rate is determined by the apparent risk. Stock with higher risk earns a higher discount rate. As outcome lower multiple is earned

Inflation function also play role in earning of higher discount rate and it lowers multiple. It is assumed that due to inflationary effects future earnings are worth less. Here we list these key fundamental factors.

Earnings base level i.e. EPS, cash flow and dividends (per share)
Growth expectation about earnings base
Inflation function i.e. discount rate
Risk apparent to the stock

Analysis of Technical Factors

They comprise external and internal factors to set market supply and demand for securities. Some factors i.e. economic growth indirectly affects fundamental factors and contributes to the earnings growth. Technical factors consist of;

Inflation: It is an input for valuation multiple, inversely correlated to valuation multiple. In some situation when inflation is high multiples are low and vice versa. Deflation declines companies pricing power and generally it is bad for securities.

Economic strengths: It is a fact that if one sectors is badly affected by economic or market factors, suddenly others will also be affected. Companies try to follow the market or industry trends. All stock movements are governed by the over all market or industry fluctuations.

Substitutes/competitors: Companies globally compete for investments with other asset classes i.e. Govt. bonds, foreign equities, corporate bonds.
Trends: Trends don’t help us to forecast about expected earnings. However stocks tend to move on the basis of short term trends.
Liquidity: Each stock has different liquidity levels. The some market have high liquidity i.e. Wal-Mart’s stock, large cap stocks. It depends on investor’s interest and attention towards special securities.
Incidental transactions: these are planned transactions occur due to portfolio objectives i.e. a company or institution trade stocks to hedge some investments. They impact demand and supply of stocks and affect the stock prices.

Reaction to Market Sentiments

It deals with attitude of market participants i.e. investors. It includes many factors i.e. global events, price history, different reports about economy etc. it is not merely based upon facts but on judgments.