Investors in the stock market often grapple with the contrast between a stock's value and its price, which can heavily influence their decisions. Understanding these two concepts is crucial in stock market investing.
The 2008 real estate crash highlighted this idea vividly. Despite houses having an estimated value based on assessments, they ended up selling for significantly lower prices due to the limited amount buyers were willing to pay in the market.
Investors determine a stock's value by examining various factors like past and projected earnings, market share, sales trends, competition, and specific metrics such as the P/E ratio (price divided by earnings per share). Analysts who follow the company also provide insights through their reports.
Most of this information is easily accessible and grounded in published facts and figures, but interpretations of these numbers can vary. Despite a company appearing strong on paper, if it ventures into new business areas via mergers or acquisitions, financial success isn't guaranteed.
Professional stock market analysts earn good incomes by analyzing these facts and figures, assessing the likelihood of success or failure, and ultimately estimating a stock's value—what they believe it should trade for on the market.
Usually, a stock's price aligns with its value, except for daily fluctuations influenced by market shifts. However, there are instances where a stock's trading price, the amount it's bought and sold for in the market, can significantly differ from its actual value. This trading price is the figure agreed upon by a willing buyer and a willing seller, independent of each other, in an open market transaction.
A stock's value is determined by the amount someone is willing to pay for it.
Certain fundamental factors influence stock prices in the long term, but in the short term, stock prices are primarily governed by the law of supply and demand. When there are more buyers than sellers, stock prices tend to rise, while an excess of sellers over buyers often leads to price declines.
The number of buyers or sellers for a particular stock on a given day is influenced by various factors like market trends and current news, irrespective of whether it's positive or negative. Economic conditions and consumer confidence play a role too. Additionally, company-related news such as earnings reports, financial situations, or scandals can also impact stock prices.
Traders focus on a stock's price movements, while investors prioritize understanding its actual value.
Traders focus on making money by predicting and taking advantage of price changes in stocks. They aim to profit from correctly guessing which way prices will move.
Investors, on the other hand, care more about a stock's actual value. They decide whether to buy or sell based on their judgment of a stock's worth over the long term.
However, thinking long-term doesn't mean just buying and forgetting about stocks. Investors need to regularly check the value of their stocks because the market changes quickly. This helps them avoid holding onto failing stocks and missing out on potential profits by selling promising ones.
NOTE: The information provided by The Balance doesn't offer tax or investment services or advice. It's presented without taking into account the specific financial situation, risk tolerance, or investment goals of individual investors. Keep in mind that this information may not be suitable for everyone. Investing always carries risks, including the potential loss of the initial investment amount.
According to the Efficient Market Hypothesis, a stock's price represents the company's value. Another theory called the Intrinsic Value Theory says that a stock's price reflects the company's earnings. But whether one theory is true or not, when a company performs well or reports strong earnings, its stock price usually goes up. This shows a connection between the company's value and its stock price.
When thinking about a stock for long-term investment, there are specific things to check. To find a good investment, it's important to understand how the company earns money, its competitiveness in the market, if the stock price is fair, and how well the company can handle market downturns. These factors help determine if a stock could be a strong long-term investment.
