If you're new to investing in the stock market, one of the most important facts about a stock is that its price does not always reflect the company's financial health. Many variables underlie the present per share price of a stock. Sometimes a firm's high performance is the main cause, and sometimes it isn't. Supply and demand issues on the market are an important variable when figuring out what is driving prices.
Study the earnings and profits of a company. This will give you a strong baseline. If the stock under review is going up, and the firm is earning strong profits, then this fact alone can explain the stock price. However, it is often only part of the story.
List out and define the main variables that dictate stock market prices. A few of these will be the present state of the economy, gross domestic product (GDP) growth, present interest rates, the bond market's performance, the growth of the stock market as a whole, and the threat of inflation. These are just a few.
Include a variable that deals with demand. This can be as simple as figuring out whether media coverage of the firm is making it a popular choice. This is probably a rough figure. At this stage, all you are doing is clarifying the demand issues surrounding a stock. This, in itself, is often not an economic variable, but a social or psychological one.
Perform a regression analysis. Regression analysis software is easy to use on your own home computer. The dependent variable will be the movement of a stock's price. The independent variables will be all those already listed. The main independent variable will be the demand for a stock as a rough figure, the other variables will be basically control variables.
Analyze the p scores of all the variables in your results. P is the most important score in a regression model. It shows how significant each variable is — in this case — in explaining the movement of s stock price. If the p scores show high significance for the demand issue, then you have a fairly scientific figure for the amount of price fluctuation that is caused by demand. If the p score is low for the demand variable, then other issues are driving the price, not demand.
Write out the results in plain English what all this means. If the p score attached to the demand variable is high, then it means that demand, not firm performance, is driving the price of the stock. In general, if many stocks are being driven by demand, then you have a potentially dangerous situation that can create a bubble and stocks are overvalued. Therefore, these kinds of analyses are important in grasping the real cause of price movements.
- Doing regression sounds daunting, and it can be. It is the only way this figure can be calculated with any scientific accuracy. Brokers are running regression analyses all the time. The only real problem is entering in all the relevant data for the time period you are concerned about. If you are working with a broker, then he might be able to send you this data.
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