If we knew perfectly what causes the stock prices to change, we could have timed its purchase to perfection. Generally speaking ‘Mr. market’ causes stock prices to change so instantly. In this article we will see how Mr. Market influences the stocks prices cause it to fluctuate like a boat in rough sea.
The main force of Mr. Market on stock price is caused due to ‘demand and supply’ of stocks. This logic is simple, if more investors are buying a stock (high demand) its price will go up, and if investors are selling a stock (high supply) then its price will fall. The same logic applies for any item in the market. But what makes stocks so special is that at times it is difficult to find a valid reason why people are buying/selling and a particular stocks. You may not believe this buy market is heavily driven by emotions than by logic.
The most common reason that can trigger buying or selling of stocks is ‘news related to company’. It is most important to understand that which news is good for company (so that we can buy its stocks) and which news is bad for company (so that we can avoid or sell its holdings). The problem is that there is no set rules and philosophies about analysis of rules. In this world there are as many stocks as there are investors, and everyone has their own set of philosophies of buying and selling of stocks. Starting from Warren Buffett who believes in value investing to the common day traders who treats stock market as a casino.
There is one news about company that almost all investors across the world believes in is ‘companies financial reports’. Listed companies are obliged to announce/publish their financial performance every quarterly and annually for the information of the market. The data’s published in the financial report can be treated a most reliable news that investors can use to make buy/sell decision.
Within the companies’ financial reports the most important parameter for investors is available in the profit and loss accounts listed as ‘Earnings or Net Profit’. The logic is simple, a company which is making higher profits will be preferred by investors. Higher earnings figures will cause the stock demand to go up resulting is higher prices. In ideal world, stock price should be driven by companies cumulative earnings called as ‘reserves’ and by ‘earning history’ (of say last five years). If a company which is continuously increasing its earnings/profits years after year for say last 5 years can be considered to be a good company to invest in. But for sure we need to check if the current market price is at undervalued levels or not. In order to analyze and compare earnings of different companies, some useful ratios has been developed like Earning Per Share (EPS), Price Earning Ratio (P/E) and Price Earning Growth (PEG). Lay investors can use these ratios to make a wise buy/sell decisions.
Apart from companies earnings there are other speculative factors that also influences stocks prices in the market. Stocks are heavily dominated by Investment Institutions like Mutual Funds, Large Investors like Warren Buffett, Foreign Institutions etc. Any positive or negative steps (buy or sell) by these institutions heavily effects the market price of stocks and Stocks Market overall. Suppose there is a crisis is Europe and Institutions from this region decide to book profits (selling stocks) fearing tough times ahead in their country. In this case there will be heavy selling resulting is stock prices to fall even though the fundamentals of stocks (like earnings, reserves, ratios etc) are very positive. Common investors do know to read financial reports of companies, so when they see steep fall in stocks prices, they also start to selling bringing a stage of panic in the market.
Do not bother about ever changing market price of stocks, this is an inherent quality and it will not go whether you worry about it or not. So let’s accept this fact that stock prices are highly volatile and will continue to change and remain speculative. We need to think how to take advantage of this stock price changes, as due to this volatility the price falls to undervalued levels. This is the moment when you shall buy some quality stocks. Using this stock price volatility to his advantage has made Warren Buffett the world best value investor of all time.