An entire industry of analysts and technicians works diligently trying to predict stock prices. The fact that many predictions are wrong attests to the fact that it is difficult to pinpoint exactly what makes up a stock price. The primary definition relates to earnings per share (EPS) and how the marketplace values EPS through the price/earnings ratio. However appropriate that is as a valuation, it doesn't explain why a stock price occasionally rises after a bad earnings report or falls after a good one.
Fundamental analysts believe a stock price is based on the intrinsic value of the company. This intrinsic value is demonstrated by the company's ability to keep revenues high and costs low, resulting in profits, or earnings. Fundamental analysts reason that a solid earnings report leads to higher stock prices. Each stockholder is a fractional owner of the company, so if the company boosts its earnings per share, the value of ownership also grows. When the value of ownership grows, so does the price of the stock, or so the reasoning goes.
Ideally, a company that is growing reliably and has a good outlook for future growth merits a higher premium on its stock value, so its price/earnings ratio rises. If a company earns $1 per share, and its price/earnings ratio is 20, fundamental analysts expect the stock to trade at $20 per share. Price/earnings ratios are market-driven. If the economy enters a recession, price/earnings ratios tend to decline because the outlook for strong earnings declines. When the economy is booming, price/earnings ratios rise. Movements in price/earnings ratios move the stock price as well. However, fundamental value is not the only thing that goes into creating stock prices.
Like any dynamic marketplace, the stock market is affected by the forces of supply and demand. When there are more buyers than sellers of a stock, its price rises. When there are more sellers, its price falls. Technical analysts define stock price as a result of the supply and demand for the stock. Pure technical analysts don't pay much attention to intrinsic value. They study the price charts of a stock and apply technical analysis methods to attempt to determine what the price will do next. After all, they reason, a stock's price is determined by its most recent sale in combination with the number of buy and sell orders waiting for execution.
Apart from fundamental and technical analysis, there is a mysterious component of stock prices that is governed by investor sentiment. Sometimes both technicals and fundamentals indicate a stock should go down in price, but if enough investors love the company and buy the stock out of fondness for the company, the stock price will rise. This is a case of more buyers than sellers. So a stock price is not an easily definable thing. It has many components that most of the time agree, but occasionally do not.
Victoria Duff specializes in entrepreneurial subjects, drawing on her experience as an acclaimed start-up facilitator, venture catalyst and investor relations manager. Since 1995 she has written many articles for e-zines and was a regular columnist for "Digital Coast Reporter" and "Developments Magazine." She holds a Bachelor of Arts in public administration from the University of California at Berkeley.