Have you ever wondered who decides the prices of the shares you want to buy?
Supply and Demand
Share prices are decided by the number of investors who want to purchase the shares and how many they are. Therefore the stock market works in almost the same way as other financial markets. When a share is bought the buyer purchases that share from another person who owned the share previously. The exact price that the share is purchased for turns into the new price per share. It works exactly the same when a share is sold the price it was sold for turns into the new price per share.
This is only one piece of the puzzle because there are other opinions and sources stating that supply and demand do not decide stock market prices. There are several other factors that play a significant role in how stock market prices are decided.
Voting Machine?
Benjamin Graham, a prominent investor who has been very outspoken about the stock market stated that in the short run, the market is a voting machine. He also remarked that in the long run, the share market is a weighing machine.
It is not possible to be able to foresee how a stock is going to perform or what it is going to do. The only thing that you can do is study the exact movements of the price.
So what exactly did Benjamin Graham mean by his statement?
For stocks that are in high demand when the buyers and sellers are bidding regularly, and asking for new prices. The market price is decided by these two factors- if there are more investors and traders willing to purchase then there are sellers the price will rise. If there are more sellers than buyers the exact opposite will happen to the price.
This is what Benjamin wanted to explain with his statement. On the other hand, according to investors’ experiences, the share price is determined by what investors are willing to pay for a share and what price the shareholders are willing to accept in order to part with their share or shares.
Weighing Machine?
As I wrote in the previous paragraph Benjamin Graham, a prominent investor who has been very outspoken about the stock market stated that in the short run, the market is a voting machine. He also remarked that in the long run, the share market is a weighing machine.
So now that we have broken down what Graham meant when he linked the share market to a voting machine, let’s break down what he wanted to convey with the term weighing machine.
During long periods of time, share prices are decided by how much money a company is able to generate. Some people say that a stock is a share of a business and therefore its value rises when the business is doing well.
I disagree with that because Amazon who was doing great in 2019 in terms of generating money their share price still plummeted. In my opinion, a share price is mostly determined by predictions. In 2019 Amazon failed to surpass or meet the expected earnings predictions for several quarters. As a result that the stock price plummeted even if the company was doing great in terms of earnings.
Now back to Benjamin Graham. His pupil Warren Buffet says that a stock is worth how many cash flows it will earn within its lifespan. He also says that the price should be discounted. Warren estimates the earnings the company will rack up over the next couple of years and then he discounts the years, because of inflation.
It is very likely that a share will drift away from the valuation resulting from Buffet’s method of calculating the share price. When the share price is lower than what it should be worth. Naturally, the price will go back to a fair value as the market weighs the price based on a company’s earnings.
When the stock is priced at a price considered less than the fair value it is time to pounce. Investors who pounce will make much money if they are patient and are willing to wait for the price to go up over time.
How does the market Cap affect the Price?
The market cap of a share is identical to the number of shares issued multiplied by the price. The price being mentioned is the amount of money it would require to purchase all the shares that a company issued. Stocks are typically used as a way to generate money to finance the business. Therefore it is critical to take the market cap into consideration when you calculate the price. If more shares are put into circulation by the company the lesser percentage of the company you own.
The more of something being made the less valuable it becomes. For example, the main reason why Bugattis are so expensive is, that they are not that many being constructed.
Summary
To summarise this article it is important to relay the factors deciding the stock market price. These factors are supply and demand, the so-called voting machine, the weighing machine, and the market cap.
It is also critical to understand that these factors are based on different people’s opinions and perceptions. However, what they agree on is that supply and demand is a factor that is linked to the stock market price decision process most of the different factors.
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