A stock’s price is what investors are willing to pay for it. Investors commonly buy a stock when they believe its price is going higher, hoping to sell it at a profit later. Some of their reasons are pretty straightforward; others might surprise you.
A share of stock represents a proportionate ownership in a business. Businesses are valued on the amount of money they make. If a business goes from making $100,000 annually to $1 million while the share count remains the same, its stock could be worth 10 times more.
Business value can be real or expected. For example: The value of a restaurant chain can be based on how much money it is making now, and on how much more it can be expected to make in the future by opening new restaurants. Another example: When the chances increase that an unprofitable biotech company will get a new drug approved by the U.S. Food and Drug Administration, investors begin to value its shares based on the size of the potential market and on its projected annual sales if and when the drug is approved.
Supply and Demand
The faster a business grows, the more willing investors are to purchase its stock, and the more they are willing to pay for it. If the supply of stock remains the same while the demand for it increases, the stock price will go up.
Nothing motivates investors to buy a stock more than a rising share price. Such situations can become self-fulfilling prophecies when a rising stock price attracts more investors, who are willing to pay more for the stock. Momentum traders buy stocks simply on the assumption that once an uptrend starts, it is likely to continue They don’t bother to find out why a price is moving up, or even what a business does.
Enhancing Shareholder Value
Corporate executives often have a vested interest in making company stock go up, either because it increases the value of their stock options or because their compensation is tied to the stock price. Because it is easier to make the stock price go up than to increase company profits, top executives sometimes spare no effort to push up the stock price. One way is to buy back company shares in the open market: When the number of shares decreases, the business value per share increases, making the stock more valuable. Another way is to boost sales by buying a fast-growing business with company stock – a virtual currency that executives can literally create out of thin air by issuing additional stock to pay for the acquisition.
- One Up on Wall Street; Peter Lynch
- The Alchemy of Finance; George Soros
- A Random Walk Down Wall Street; Burton Malkiel