FOOL SCHOOL
What Makes A Share Price Move?

February 8, 2002

A short and simple question, but it's one that baffles many people. The short answer is 'everything'. But let's look at the long answer as well.

First of all you need to know what a share is and what the price represents. A share represents a part ownership of a company. The total value, or market capitalisation of a company, is calculated by multiplying the share price by the number of shares in issue. So when we ask what makes a share price move we are really asking what makes the value of a company change.

Note that the actual price itself doesn't tell you anything. Think of it like a very big pizza. A share is effectively a slice of the pizza. If I said 'I'll sell you a slice for £1' hopefully the first thing you would say is 'how big is the slice?' It's the same with shares. You need to know the size of the slice to work out if the price is cheap or expensive. But we all have a good idea of what we would pay for certain size slice of pizza. How do you estimate the value of a company?

Let's use a small, simple business as an example. Say you owned a shop. How much would it be worth? The exact answer is all the cash you can take out of a business from now until the business closes down. Cash in your hand now is worth more to you than cash in the future because you can spend it now and inflation will erode its value.

However, you can't tell how much cash you can take out each year and how quickly the value of future cash flows will erode. So you have to estimate them. It is the value of these estimates that determine how much a company is worth. Everyone will come up with a different estimate so everyone will have a different view on what a company is worth. Some estimates will be very broad brush whilst others will go into a large amount of detail.

People often base their estimates on the performance of the business at the current time. This is referred to the fundamentals of a business. If these change then is it likely that the estimates based upon them will change and hence so will the share price. The fundamentals of a business change very slowly. However, expectations can change at the drop of a hat. This is why share prices change so much from day to day and in fact even during one particular day. Expectations can change due to new information about a company, its industry or the economy. They can also changes due to a new interpretation of old information. All of these can affect the share price.

Every share has a fundamental value and this value changes as time marches on. However, the share price is something different. It is the average of what everyone thinks that fundamental value is. Sometimes is too low. Sometimes it is too high. It is highly unlikely to ever be 'correct' for any noticeable period of time. However, it is the price at which shares get bought or sold, regardless of whether you think it is too high or too low.

That's enough with the theory. Let's look at how it works in the actual stock market. In any market you need buyers and sellers. A price will be set where the supply of shares equals the demand for shares. Stockbrokers carry out buying and selling on your behalf and market makers sit in the middle balancing supply and demand by setting a price for each individual share. If people are optimistic about a company fewer will want to sell and more will want to buy. Therefore the price will rise. The opposite applies as well.

When a company releases any new information onto the market this can affect the price as well. In many cases the price of a share will reflect what people expect to see from such announcements. If a company does better than expected its price is likely to rise. If it does worse then it is likely to fall. If the announcement is a surprise, such as a sudden takeover, then the share price is likely to move significantly and very quickly.

We often see remarks on the boards that a company has released good results so why has the share price fallen. They may have been good but investors as a group, often called 'the market', might have been expecting something better. Additionally they are always looking forward to future performance rather than resting on past victories.