Imagine a tornado-like tunnel of energy, whirling through space. At the tunnel’s top, global and geopolitical events, economic conditions, the forces of supply and demand, and interest rates spin furiously. They funnel down into the sphere’s vortex, igniting sector trends, earnings, and investor sentiment. The vortex narrows, spiraling down . . . until all elements converge into a single point: price.
Price determines the value of an object agreed upon in a given moment in time. It is consensus of opinion. Price represents a present perception of value that both the seller and buyer agree to…right now. This price can be based on complicated algorithms or on the appearance of the new moon. You and I can consider the price to be “right” or “wrong.”
Either way, it doesn’t matter to the market. Have you heard the old market saying, “The market is always right?
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So, why do we invest? Please remember, the stock market is a forward-looking entity. As investors, we buy and sell our stock shares depending on how we expect the future of the underlying company to unfold.
Maybe you’ve been holding shares of Bossy Bank and earned a nice profit in it. Now, however, you’ve heard banks are headed for an unstable quarter. You’d like to take Bossy’s current gains and look for greener pastures.
I, on the other hand, have been watching Bossy for some time now, and am convinced its earnings will grow and its shares will move higher.
In the world outside the stock market, as long as seller and buyer agree, the seller receives the amount that the buyer believes it is worth, at that precise moment in time. If that true in the financial markets, then I would pay you the amount for your shares dictated by Bossy’s fundamental information and its book value.
When we buy an item as an investment, however, our objective is quite different. Whether we’re speaking of a work of art, a classic auto, a rare stamp, or shares of stock, we buy with expectations that our investment, if wisely chosen, will increase in value.
That means, if I purchase your shares of Bossy Bank, I might purchase them at a higher price, or a premium, than their fundamentals and book value dictate (book value = dollar value remaining for common shareholders after all debts are paid), as I expect capital appreciation to increase over time (increased share value plus dividend). If Bossy’s earnings negative and fundamentals are appalling, the current stock price may be listed at a discount to the fundamental value. Thus, I wouldn’t want that stock.
The variable between a stock’s real share price dictated by fundamentals, versus the price investors participants expect it will be worth in the future, causes price fluctuation. In the long-term, winning fundamentals will propel a stock’s price higher.
In the short-term, however—and as we are seeing right now—the powerful emotions known as greed and fear have a definite say in current price value, and they have the power to propel stock prices higher or lower.
Until next time, keep green on your screen!