This may seem a rather strange question, how do markets value stocks, but if you sit down and think about it, how does it happen? What is the process and what are the factors taken into consideration when the markets arrive at a share price? If you can understand how markets value stocks and how individual share prices emerge, this will help you in your quest for a long-term career in the investment industry.
Information exchanges
We have touched on this before, but if you assume that stock markets are information exchanges where different views and opinions are inputted, considered and used to value stocks and shares, you are along the right lines. There are obvious many different factors to take into consideration such as company announcements, events going on behind-the-scenes as well as research notes and broker recommendations, but at the end of the day these are just some of the elements used to value stocks and shares.
The consensus leads
Once all information has been inputted into the information exchange, via those buying and selling shares and announcing news and views, a consensus will emerge and the share price will react accordingly. Share prices are liquid and therefore they constantly change as new views and information are entered into the market/information exchange. That is all stock markets are, information exchanges where different views and opinions are considered and a share price will react accordingly.
Market manipulation
Have you ever noticed that the vast majority of attempts to manipulate the market in a particular share tend to have a relatively short lifespan? It will depend upon the company, the news and the rumours created as to how quickly a “fair price” will be arrived at. If there is constant shortselling of a share and misleading information is leaked to the market this can sometimes result in a significant fall in the share price. The reality is that the fall is based upon misinformation and market manipulation although when investors finally click on to this, they will see the short term fall in the share price as a buying opportunity and the shares will eventually find their “fair value”.
There are obviously different degrees of market manipulation as we have seen in recent months with exchange rates and other spot markets. However, more often than not prices will return to their fair value fairly quickly.
Inside information
Have you ever watched a share price where everything seems to be going well, the news is positive, the results are better than expected yet the share price does not seem to reflect this? Very often when share prices are “underperforming”, or not performing as many had expected, there are events going on behind-the-scenes which may have been leaked in the form of inside information. Whether or not individuals or companies deal on this inside information, if it becomes part of the information exchange then it will have an impact upon the share price. Remember, by law companies are only able to announce information which is true and confirmed and very rarely do they comment on speculation otherwise they would be commenting nearly every day!
Conclusion
We have touched on this before, the stock market is but an information exchange which takes all views and news into account, buys and sells, and then arrives at a “fair value” for each and every share price. Sometimes it is the information which is not in public domain which can impact a share price more than information readily available. If share prices are not performing as you would expect there may be things going on behind-the-scenes which are leaking into the market, via rumours or actual dealing by individuals, which can sometimes override all of the positive news in the public domain.
Once you learn to read the markets, listen and understand what they are saying to you, you will then be in a position to maximise your investment returns in the future.