The Explainer: Stock Market - Part III
About an hour ago, the courier guy delivered a parcel containing a copy of Monsoon by Robert Kaplan. Geopolitics and geostrategy have always fascinated me; in fact, along with history, philosophy, and literature, I just love these two ideas.
I will keep this post short, that is because I am eager to start reading the panoramic sweep of ideas that this book promises. In this week's The Explainer, I will focus on factors that influence share price.
What factors influence share price?
The major factors are:
(a) company performance & dividend income;
(b) speculation;
(c) industry prospects, and
(d) government policy.
If a company is running profitably, investors would definitely show interest in owning shares of such a company. As the business churns out profit, it may reward its shareholders with rising share prices.
Also, some investors buy shares with an eye on dividend (distributed profit; return on investment in shares). When the company declares dividend, it distributes the profit among the shareholders. A company that declares dividends on a consistent basis will attract investors.
However, there is demand from investors even if the company does not declare dividend. Thus is because if the company does not declare dividend, it would convert the profit into cash reserves, which can be used to buy other companies, invest in better technology, and to ride over rough market times.
For example, Apple Inc. has not declared a dividend since 1995! It is sitting on a cash pile of U.S.$75 billion. Its share price has gone by more than four times in the last four years. I think you have got the point.
(b) Speculation
In India, most people invest to reap a profit in the short term, and not to maximize the value of their capital appreciation in the long run. Given the nature of India’s stock market, speculation is the norm, not the exception!
Speculation can lead to volatile movement in share price, even in a short time. A few years back, in a mail to a student I explained speculation in the following manner:
You buy the shares of Company A because you believe somebody else will pay more for it in the future. Now the reasons for the expected price rise do not really matter. All that matters is the belief that the share price will rise. Such speculators (short-term traders) don’t base their buying behaviour on factors like company performance. Most bubbles in the stock market are the result of large-scale speculative trading. It is in the nature of a bubble to burst, and when it bursts, it takes with it a large number of speculators down the drain.
In the same way, a company’s poor performance, poor earnings outlook, missed dividend payment, or even speculation can drive its share price down.
There is another major factor: the company's performance against its peers. But I will stop here. Monsoon is waiting for me! Thank you!
I will keep this post short, that is because I am eager to start reading the panoramic sweep of ideas that this book promises. In this week's The Explainer, I will focus on factors that influence share price.
What factors influence share price?
The major factors are:
(a) company performance & dividend income;
(b) speculation;
(c) industry prospects, and
(d) government policy.
(a) Company Performance & Dividend:
Investors often keep an eye on a company’s performance, especially with regard to its earnings. Often, you must have observed that your investor-parent / uncle / sibling or simply any player in the stock market pays great attention to the declaration of the company’s earnings (quarterly or half-yearly or annual).
Investors often keep an eye on a company’s performance, especially with regard to its earnings. Often, you must have observed that your investor-parent / uncle / sibling or simply any player in the stock market pays great attention to the declaration of the company’s earnings (quarterly or half-yearly or annual).
If a company is running profitably, investors would definitely show interest in owning shares of such a company. As the business churns out profit, it may reward its shareholders with rising share prices.
Also, some investors buy shares with an eye on dividend (distributed profit; return on investment in shares). When the company declares dividend, it distributes the profit among the shareholders. A company that declares dividends on a consistent basis will attract investors.
However, there is demand from investors even if the company does not declare dividend. Thus is because if the company does not declare dividend, it would convert the profit into cash reserves, which can be used to buy other companies, invest in better technology, and to ride over rough market times.
For example, Apple Inc. has not declared a dividend since 1995! It is sitting on a cash pile of U.S.$75 billion. Its share price has gone by more than four times in the last four years. I think you have got the point.
(b) Speculation
In India, most people invest to reap a profit in the short term, and not to maximize the value of their capital appreciation in the long run. Given the nature of India’s stock market, speculation is the norm, not the exception!
Speculation can lead to volatile movement in share price, even in a short time. A few years back, in a mail to a student I explained speculation in the following manner:
You buy the shares of Company A because you believe somebody else will pay more for it in the future. Now the reasons for the expected price rise do not really matter. All that matters is the belief that the share price will rise. Such speculators (short-term traders) don’t base their buying behaviour on factors like company performance. Most bubbles in the stock market are the result of large-scale speculative trading. It is in the nature of a bubble to burst, and when it bursts, it takes with it a large number of speculators down the drain.
In the same way, a company’s poor performance, poor earnings outlook, missed dividend payment, or even speculation can drive its share price down.
(c) Industry Prospects
Another major factor that plays a major role in determining the share price is the industry outlook. Investors (am not talking of speculators) like certainty; stability is good for business. The nature of business environment often determines the growth of an entire industry. For example, the current outlook of the U.S. and Eurozone economies is pessimistic and negative; these are the major markets for the IT and ITeS (IT-enables Services, like BPO) sectors. Now if the clients in these markets scale down their deals with Indian companies in these two sectors, the latter's performance will also suffer. This will, in turn, impact the revenues, profits, and overall business. It is these negative factors (i.e. downturn and fears of recession in the U.S. & Eurozone economies) that have brought down the share prices of IT companies in the last few weeks.
(d) Government Policy
Government policy can also play a vital role in influencing share prices. The government's has a positive attitude toward a particular sector / industry can help send positive signals to the investor community. Government incentives may include tax holiday and supply of land and power at concessional rates.
Government policy can also play a vital role in influencing share prices. The government's has a positive attitude toward a particular sector / industry can help send positive signals to the investor community. Government incentives may include tax holiday and supply of land and power at concessional rates.
For example, if the government gives tax holiday (no tax payment for a specific number of years) to companies in a specific sector, then the company need not pay tax, thus saving precious money and build reserves or pay dividend.
There is another major factor: the company's performance against its peers. But I will stop here. Monsoon is waiting for me! Thank you!
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