Those who invest in the stock market often try to resolve the difference between a stock's value and its price. Many moves can depend on these factors. You know that value and price are two different measures arrived at by different means if you've spent any time investing in the stock market.
The real estate collapse of 2008 put a spotlight on this principle. Many houses that may have had a value derived from appraisals or other means ended up selling for much less money because that was all the market was willing to pay.
Determining a Stock's Value
Investors in the stock market can pinpoint a stock's value by looking at factors such as earnings (past, present, and future projections) and market share. You would look at sales volume over time, future and current competitors, and a variety of metrics such as P/E ratio, the current price divided by current earnings per share. A review of reports by analysts who follow the company can factor in as well.
Most of this is pretty easy to pinpoint. It's based on published facts and figures, although there's still plenty of room for interpretations of the numbers. A company may or may not be successful financially, no matter how good it might look on paper, if it ventures into a new area of business through merger or acquisition.
Career stock market analysts make very good incomes sorting out the facts and figures along with the odds of success or failure. They will arrive at a value, what they believe the stock should trade for on the market.
Influences on Stock Prices
A stock's price is often at or near its value, aside from daily changes due to a rising or falling market. But it can happen that a stock's price, or the amount at which it trades on the open market, is quite different from its value. A stock's trading price is the number that an arm's-length, willing seller and a willing buyer would find to be agreeable to each party.
A stock's value is what someone is willing to pay for it.
Basic factors affect stock prices over the long term, but the law of supply and demand rules stock prices in the short term. It can mean that the stock's price will rise when there are more buyers than sellers, while more sellers than buyers can mean that the price is about to fall.
The number of buyers or sellers for a given stock on any day depends on many factors, such as market trends and the current news. It doesn't matter whether that news is good or bad. The economy will have an effect, as well as consumers' confidence in the economy or the lack of it. Company news, such as earnings, financial issues or scandals, can factor in as well.
Traders tend to be more concerned with a stock's price and with its ups and downs. Investors are more concerned with the stock's value.
The Bottom Line
Traders live on price changes, whether they're going up or down. They make money by figuring out which way prices are going to move, then taking a position so they can profit if they make a correct trade.
Investors are more concerned with value because their judgment of value will guide them as to whether they should buy or sell their holdings over the long term.
Taking a long-term view doesn't mean to buy and forget because the market changes, and it often does so quite quickly. It's key for investors to assess their stocks' values on a regular basis. This makes it unlikely that you'll hold a failing stock or make the mistake of selling one that has strong prospects.
NOTE: The Balance doesn't provide tax or investment services or advice. This information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor. It might not be right for all investors. Investing involves risk, including the loss of principal.
Frequently Asked Questions (FAQs)
How does a company's value affect its stock price?
According to the Efficient Market Hypothesis, the price of a given stock reflects that company's value. Another theory behind stock prices, called the Intrinsic Value Theory, states that the stock's price shows the value of the company's earnings. Regardless of which is correct, when a company does well or has strong earnings reports, its stock price usually increases as well, showing a basic correlation between the company's value and its stock price.
How do you determine if a stock is worth buying?
When considering if a stock would make a powerful long-term investment, there are a couple of different criteria an investor should look for. These signs of a good investment include being able to describe how they make money, if they are in a competitive niche, whether the stocks are set at a fair price, and how well the company can survive a drop in the market.