There are many factors that affect the price of a stock, The most basic factor is investor perception. The perception of the likelihood of receiving a good return on the investment is what drives most investors to a particular stock. This return can be in the form of price appreciation or dividend income. While there are real factors that affect a company's performance, many good companies have undervalued stock because they have not attracted speculative investor attention.
Earnings Per Share
The investor knows that a successful company will earn a substantial profit, which will result in strong earnings per share. Divide the net earnings of a company by the total number of shares of stock outstanding, and you get the earnings per share. Earnings are affected by company management, market sector dominance and cyclical industry performance. A good analyst report or a general perception that a company will benefit from one of these factors and post good earnings tends to increase the price of the stock as speculators buy in anticipation of price appreciation. When a company announces good EPS, the stock price generally rises, but not always. Some companies, such as biotech and Internet companies, frequently have high stock prices with little or no earnings per share.
During the dot-com bubble, investors perceived great futures for certain young companies such as AOL and Amazon, and bought their stock in anticipation of good earnings at some time in the future. The same happens with certain biotech companies that appear to have created a medical treatment that will cure a major disease. Stocks of companies in new and promising industries often trade at high earnings multiples -- market price divided by EPS -- because of the perception that one day those companies will have high earnings.
During recessions, investors buy defensive stocks they expect will perform well when the economy is bad. Classic defensive stocks include companies that produce necessities such as: tobacco, liquor, food and personal products. During boom times, autos, electronics, appliances, travel and hospitality stocks perform well because consumers have money to spend. Even though these stocks don't always perform as expected, investors tend to adjust their portfolios to over-weight those stocks and the stock prices rise as a result.
Companies that have net profits have a choice of using those profits to grow the enterprise or sharing some of the profits with their shareholders. A dividend tends to keep the price of a stock stable during market fluctuations, and tends to support the stock during periods of high interest rates when the stock market usually contracts. Dividends also aid in the image of corporate stability, until some difficulty requires the company to lower its dividend. Companies resist lowering their dividends because it generally detracts from an image of financial strength, though it is sometimes looked on as a wise corporate strategy and results in stock sales.
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