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 Market Mysteries of the week

  What does it actually mean when a company’s stock price falls?

Answer:

It means that a company is less valuable.

Investors have less confidence in the company's ability to grow and succeed.

Where does a stock price come from?

A stock is a single slice of a company

. If investors value a company at $10 billion, and the company decides to split its ownership into 100 million shares, each share of stock is worth $100.

The stock price itself isn't important in absolute terms on its own. A company with a stock price of $50 could be more valuable than one with a stock price of $100 if the company decided to split itself into more shares.

It's always important to understand the company's total value, also known as market capitalization

if you're interested in learning how big that company is. Otherwise,

you only have to worry about the direction the stock price is moving

. That's what's more important to a shareholder because no matter how much each share cost, your money is still going to grow or decline by the same rate the company's stock price rises or falls.

How do investors value a company?

Just like most things, value is in the eye of the beholder, and

the price is based on the balance of supply and demand

. If more investors want to own a company, demand for its shares increases, and its share price increases. If investors lose confidence in a company, demand decreases, and its share price decreases.

The stock market works like most other markets. Some people buy things on impulse or based on popularity and social proof. Some people like to figure out a specific price they would be comfortable paying and wait to buy it at that price.

Professional investors have an endless number of ways to identify the specific price they want to pay.

Typically, investors take some measurable component of the company's success, like profits or cash flows, and multiply it by some markup.

That markup is totally arbitrary. The magnitude of the multiplier correlates to the investor's confidence in the company's future. Investors are buying ownership in a company for a share of its future growth and profits, so they look at what it's producing now and then assess their confidence in its ability to sustain and grow that production. Innovative, faster-growing companies like Tesla get bigger multipliers because people have a lot of confidence in their potential.

What's happening when a stock price falls?

If a company's stock price falls 10%, the company becomes 10% less valuable. Investors heard negative news that made them

lose confidence in the company's future success.

The value of innovative, faster-growing companies is typically more volatile because a more significant component of their value is based on investor confidence in the future.

Where does that money go?

It's just gone.

Most of a company's value is just made up. Those expensive shoes are only $10 in material, but you bought them for $100 because you thought they were worth it. A company works just the same.

It's all about perceived value.

If you create a beautiful painting and price it at $100, your artwork is worth $100. If you realize that no one wants to buy your artwork for $100, you might lower the price to $75. Now, you sell it for $75. Your painting is now only worth $75. That $25 of value is just gone. No one earns that $25, so it's just erased from the world.

Stock prices are volatile.

You'll hear about the big moves in the news because it sounds interesting, but that company's stock price might recover most of the loss later that week.

Short-term prices reflect people's opinions and confidence in the future, so they change day to day.

Feel free to share this with anyone who might find it helpful.

💙 The Share Scoops Team

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