What factors affect stock prices?
MARKET SENTIMENT: The general market can have its “mood swings”. Sometimes, people are very optimistic and are willing to pay high share prices. Sometimes the market is depressed and businesses are valued less, causing share prices to go down. The important thing is not to let the mood swings of the market affect your own valuation of the business. The easiest way to measure market sentiment is to have a look at the broadest available index, such as the KLCI.
Remember that stock prices will drop from time to time! These short-term shocks may cause many investors to panic and sell off their stocks to try and minimize their losses. Often, it will be a long time before investors are able to recoup their losses. These dramatic changes in price are very hard to anticipate in the short term, which is why stocks are more suited for an investor who’s in it for the long term.
Over a long period of time, stock prices have trended upwards. As you can see below, despite its ups and downs, the KLCI has trended upwards over time. Furthermore, historical evidence has shown that stocks have outperformed most asset classes over the long term.
Though some drops in the overall market can be quite significant (such as the period between Jan 2007 and Jan 2008), it’s always important to keep in mind the long-term trends as stated above. Avoid adding to your losses by overreacting to any short-term changes in the market.
INDUSTRY GROWTH: Industries which are growing are usually better than ones which are declining. Think about camera film – as digital photography took off, there was less demand for traditional film. You, as an investor, should then be less attracted to a declining industry like traditional film.
Certain industries, such as those involving commodities, are more cyclical and volatile. Earnings for companies in these sectors may fluctuate more. In contrast, many companies selling consumer goods (e.g. Nestle, Proctor and Gamble) have strong brands and high consumer loyalty, so their performance is likely to be more stable.
COMPANY FUNDAMENTALS: Companies that have a track record of achieving stable earnings and a history of growth will be more desirable to investors and as such will usually command higher P/E valuations.
Some characteristics of companies that are able to grow and maintain revenues and profits include having attractive products that appeal to a wide customer base, having strong management teams, and being able to show clear and consistent track records.
PROFITABILITY: Investors tend to find companies with higher levels of profitability to be more attractive. A good measure of profitability is return on equity, ROE (Net Income/Total Equity). Read more here to further understand how to use ROE when evaluating a business.
CORPORATE GOVERNANCE: Companies with good corporate governance will ensure that their shareholders’ interests are always protected. These companies generally make decisions which balance short-term and long-term needs. They also employ respected independent board members to provide the appropriate check and balance against the company’s management.
RISK: Investors will apply a discount when valuing companies that are considered riskier. These companies tend to trade at lower P/E ratios than they otherwise would have.
Common things to watch out for would be risks to the industry, the threat of competition, the potential impact of government regulations, and the company’s ability to keep up with technological innovation.
|⚠ Food for thought: Just because a stock is cheap, doesn’t mean that it’s a value buy or a good investment. Stocks can also drop in price if investors no longer want them, maybe because the company isn’t doing so well in their business or is not being managed properly. This is why it’s always important to do your research before buying!|
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