Why do stock prices change?

Question

As I understand it, a company raises money by sharing parts of it ("ownership") to people who buy stocks from it. I get that some stocks pay dividends, and that as these change the price of the stock may change accordingly.

I don't get why the price otherwise goes up or down (why demand changes) with earnings, and speculation on earnings. So what if the company's making more money now than it did when I bought the share? None of that is filtered my way as a "part owner". Why should the value of the shares change?

Answer 1

None of that is filtered my way as a "part owner".

Sure it is, it's just not always obvious. When a company makes money it either:

• Saves that money as cash or other assets
• Invests the money back into the company by buying assets in order to grow
• Distributes it as dividends
• Spends it on something that does not grow the company (wastes it)

Other then the fourth option, the first three all increase the total value of the company. If you owned 1% of a company that was worth X, and is now worth X+1, the value of that 1% ownership should go up as well.

One model of the value of a share of stock is the present value of all future cash flows that the company produces for its shareholders, which would be either through dividends, earnings (provided that they are invested back into the company) or through liquidation (sale). So as earnings increase (or more accurately as projected future earnings increase), so does the value of a share of the company.

Also note that the payment of dividends causes the price of a stock to go down when the dividend is paid, since that's equity (cash) that's leaving the company, reducing the value of the company by an equivalent amount.

Of course, there's also something to be said for the behavioral aspect of investing, meaning that people sometimes invest in companies that they like, and sell stock of companies that they don't like or disagree with (e.g. Nordstrom's).

Answer 2

As I understand it, a company raises money by sharing parts of it ("ownership") to people who buy stocks from it.

It's not "ownership" in quotes, it's ownership in a non-ironic way. You own part of the company. If the company has 100 million shares outstanding you own 1/100,000,000th of it per share, it's small but you're an owner. In most cases you also get to vote on company issues as a shareholder. (though non-voting shares are becoming a thing). After the initial share offer, you're not buying your shares from the company, you're buying your shares from an owner of the company. The company doesn't control the price of the shares or the shares themselves.

I get that some stocks pay dividends, and that as these change the price of the stock may change accordingly.

The company pays a dividend, not the stock. The company is distributing earnings to it's owners your proportion of the earnings are equal to your proportion of ownership. If you own a single share in the company referenced above you would get $1 in the case of a $100,000,000 dividend (1/100,000,000th of the dividend for your 1/100,000,000th ownership stake).

I don't get why the price otherwise goes up or down (why demand changes) with earnings, and speculation on earnings.

Companies are generally valued based on what they will be worth in the future. What do the prospects look like for this industry? A company that only makes typewriters probably became less valuable as computers became more prolific. Was a new law just passed that would hurt our ability to operate? Did a new competitor enter the industry to force us to change prices in order to stay competitive? If we have to charge less for our product, it stands to reason our earnings in the future will be similarly reduced.

So what if the company's making more money now than it did when I bought the share?

Presumably the company would then be more valuable.

None of that is filtered my way as a "part owner".

Yes it is, as a dividend; or in the case of a company not paying a dividend you're rewarded by an appreciating value.

Why should the value of the shares change?

A multitude of reasons generally revolving around the company's ability to profit in the future.

Answer 3

In addition to D. Stanley's very fine answer, the price of stocks change as a result of changing market conditions and the resulting investor estimation of its effect on the company's future earnings. Take these examples.

Right now, in the USA, there is a housing shortage; that is, there are fewer houses available for purchase than there are willing buyers. Investors will correctly assume that the future earnings of home builders will be higher than they were, say ten years ago. Seeking to capitalize on these higher earnings, they will try to buy the stocks. However, the current owners of the stock, potentially the sellers, know the same thing as the investor-buyer and therefore demand a premium to entice a sale. The price of the stock has risen.

The reverse is true, also. Brick and mortar retailers are declining as more consumers prefer on-line retail shopping. The current owners of these stocks will probably want to sell their stock before it is worth even less. The investor-buyer also knows the same facts; that future earnings will most likely be less for these companies. The potential buyer offers a very low price to entice a sale. The price of the stock has fallen.

Finally, the price of stocks rise and fall with general market conditions. As an example, assume that next months jobs report is released showing that 350,000 new jobs were created in July. Investors will believe that if companies are hiring, then the companies are doing well; they are selling products and services at a higher than expected rate, requiring that they add new employees. They will also conclude that those 350,000 new employees will be spending their salaries to buy not just food, clothing and shelter, but also a few luxuries like a newer car, a TV, perhaps even a new home (please see paragraph 2!). All of these companies will have more business, more earnings and, likely, a higher stock price.