This has always puzzled me. I can only think of two reasons that a company’s performance is relevant, dividends and the risk of bankruptcy. These don’t seem to explain, however, why Microsoft’s stock price changes based on expectations of their performance, since Microsoft doesn’t pay out a dividend and seems to have virtually zero chance of going bankrupt. So why do people care if they are in a boom year or performing under expectations - is it really a fear that MS is going to collapse and go bankrupt?
Stocks are, by definition, stakes in that companies ownership, and thus they are representative of how much it is worth to have 1/(# of common stocks issued) of that company. Thus, when Microsoft or other companies are doing well, people are more like to want to have a share in that company. When a company slacks, on the other hand, people are less likely to want to invest to be a partial owner. Even with companies that don’t pay dividends, high end stock-holders get votes (in theory, all stockholders get votes based on shares owned) that can determine company policy, so there’s a reason to own the stocks even if you’re not getting direct benefits, and it’s worth more (hence more pricey) to be on the board of a company on the rise than one on the fall.
Also, the stock market is a big roulette wheel for a lot of people so that might influence the stock to some extent.
Thanks for the speedy reply. When you say it’s “worth more to be on the board of a company on the rise,” why is it worth more if you don’t see any benefits from the company doing well? Is it just about the feeling of power, being behind the reins of a strong company?
A stock is a tiny piece of ownership in a company. When a company is performing well, the value of its assets are increasing, so the value of that tiny piece of ownership has increased.
A common stock is a claim on the assets of a company after it liabilities are settled. That differential is greater when a company is doing well. Keep in mind, if dividends aren’t paid, the earnings are retained and used to grow the company. Even if the company doesn’t pay you, the shareholder, directly, they might buy another machine or a fancy table for the break room. You are part owner of the new machine or table. This is capital appreciation.
Speculation also drives stock prices. This is sometimes called the “greater fool theory.”
That would make sense to me, but the value of that tiny piece of ownership is really only determined by the going rate for it. It increases only if more people buy it. Imagine a company that has a record year and is performing amazingly, yet people only sell its stock - the price of its stock would plummet, even though it performed well. This seems to conclusively prove that the stock isn’t inherently tied to the value of the company.
Ever hear the term “betting on the come”?
Evaluate the stock price, see that the company is performing well, buy some shares because there is a good chance they can be sold at a profit if that performance continues.
Conversely, buy some shares exptecting the company to do well, they underperform, storm clouds are forming, get rid of it before the value drops further.
It’s what’s called the “Market”. People invest in it with the intention of making a profit otherwise there is no motivation. It’s always a moving target so those that are playing are always aiming at where it is going to be, not where it is.
Understood. People certainly do buy more shares of a company that is doing well, I am totally clear on that. Also, it’s totally clear to me that people expect others to do the same.
My question is why people do it in the first place. It seems, ultimately, entirely a house of cards, that when a company does well it’s stock price goes up because people buy more of it because its doing well so they think the price will go up. I guess my problem is that it’s very circular thinking.
Over the short term, stock pricing is irrational. There is often no rational rhyme or reason why a stock price changes. Often the change is due to market psychology, general outlook at this instant, or something completely unrelated.
Over the long term, stock prices track the company’s earnings. If the earnings grow, the stock price will increase. Of course this is a generalization and there are exceptions, but it is generally true.
J.
Being on the board, or to a lesser extent being a significant stockholder who isn’t on the board, represents control of what the company will do. There are limits on this, mostly set by entrenched management, legal regulation, and public relations necessities, but in general the bigger and stronger the company is, the more valuable the leverage of ownership on it is. At least, that’s how I see it.
Also, if the majority of owners choose to demand it, they can insititute a dividend policy or even order the corporation to dissolve itself, thus instituting a flow of company funds from itself to they, the true owners. This doesn’t happen that often, but the potential for that is another reason that the stock has some sort of value in itself.
Hope that this helps.
It’s not, it IS however, due to the nature of what stock is, pretty definitively tied to how people THINK it will do. While technically, there’s no hard logic tying the price to the performance, the nature of the beast means that that (in general) simply doesn’t happen.
So no, it’s not mathematically tied, but yes, by definition, it’s a barometer of present and possibly even more so future trends (also other factors, an “evil empire” with bad press will have poor stock results, a scandal, even a non-financial one, will cause confidance in the company to plummet)