The price of a share obviously evolves according to supply and demand. This permanent opposition between buyers and sellers is influenced by many factors which interact with each other. Here is a list of the main elements that make the price of a share vary that can be grouped into two main categories, structural factors and cyclical factors.
Structural factors affecting the price of a share
Structural factors are the elements directly related to the company. Each share (company) has its own characteristics and this is what causes some to see their share price rise / fall more than others.
- Profits measure the ability of a business to generate profit from its activity. This answers a very simple question: is the business profitable?If the profits are there, it attracts investors. The more important they are, the more the action is acclaimed by investors. Conversely, a company publishing a loss over a financial year is sanctioned by investors.This is a basic reasoning because one must also take into account the rate of growth of profits. This is what attracts investors in the long term. A company that generates stable profits over time is generally a company that has reached maturity in its sector of activity. The potential for an increase in the share price is then limited. In contrast, a business showing increasing profits each year translates to a growing business. This attracts a lot of investors over the long term and the share price can go up sharply.
A company’s profit is also used to calculate net earnings per share. To do this, just divide the total profit by the number of shares. EPS is used in the calculation of many ratios that investors use to select their stocks to portfolio. Among the best known, we can mention the which is equal to the share price / earnings per share. If the profit is large, the PER decreases. Generally, it is the stocks with the lowest PER that outperform the market index.
- The amount of dividends paid depends on the profits made but also on the company’s policy. Mature companies generally pay large dividends to attract investors and compensate for the fact that the growth potential of the company is low. Conversely, young companies pay little or no dividends, with all profit being reinvested to finance the future growth of the company. The amount of dividends from different companies therefore impacts the choice of investors for a particular action. Fathers of families, for example, will choose stocks with high dividends. Management funds will focus on the most promising companies, with a strong upside potential for the stock market price.The dividend also directly impacts the share price since when the dividend is detached (when it is paid), the amount is deducted directly from the price.
- The level of debt of a company determines its financial leverage. It is calculated as follows: The greater the debt, the greater the growth potential for the company, but on the other hand, the risk is also higher. The effect of financial leverage mainly impacts the share price of a share over the long term. Everything will depend on the ability of the company to generate growth or not while bearing the cost of the debt.Depending on the level of debt of the company, this will impact the share price. If the company is efficient, the financial leverage effect allows it to increase its profits tenfold and therefore to attract a greater number of investors. The stock price can then soar just as it can fall if the company cannot bear the cost of the debt.
- Depending on the industry of a company, its level of risk is different. Cyclical sectors such as the automobile are for example more risky than an investment in a non-cyclical sector such as insurance for example. The growth potential is higher in so-called risky sectors.
Depending on the economic cycle in which the economy finds itself, it is also necessary to favor certain sectors over others.Institutional investors carefully watch the sectors of activity of companies. A so-called top / down portfolio management approach even gives more importance to the sector of activity than to the company itself.
Cyclical factors affecting the price of a share
- Cyclical factors are elements that are not directly linked to the company but to its macroeconomic environment. These factors put pressure on the price of all stock prices.
Central bank policies
- All the instruments of monetary policy used by central banks have a strong impact on stock prices. Obviously, the key rates of central banks are part of it.A drop in rates generally promotes a rise in the stock market. Indeed, low interest rates favors credit, investment and therefore an economic recovery which is beneficial to all companies. In addition, a fall in rates attracts savings (less remunerated) to the stock market, which therefore encourages a rise in the price of shares.Conversely, a rise in interest rates has a negative impact on the equity markets. An increase is generally used to fight against inflation and to increase the cost of loans. This has the effect of slowing down the development of companies and therefore their profits. On the other hand, a rise in interest rates pushes investors to favor bonds over stocks. The price of shares is falling.
- Market sentiment has a strong impact on the stock markets. We see it today, to go from a bull market for several months or years to a bear market, it does not happen all at once. Investors have a memory of the market. If for a long time they have only seen the rise, they find it difficult to change mode.You only have to look at the stock markets at the moment, many stocks have seen their stock prices soar completely irrational, without reflecting the reality of the fundamentals. This is what leads to the creation of speculative bubbles which one day or another always end up exploding …
- All the economic figures published by the main countries have a direct impact on the financial markets. The main macroeconomic data concerns employment, inflation and growth. Weak growth, for example, will push companies to slow down their investments which will have the effect of lowering their profits over time, and therefore the price of shares.The effect of the various economic announcements is also short term, this is called the announcement effect. We saw it yesterday with the fall of the European stock markets due to the announcement of weaker than expected growth in the United States (one of the engines of global growth).
- To invest well in the stock market, it is also necessary to take into account the recovery, expansion, overheating and recession. Depending on the cycle the economy is in, this influences the price of different stocks depending on the sector of activity of the companies. In a recovery and expansion phase, investors will favor cyclical stocks and growth stocks. Conversely, in a phase of overheating and recession, investors will favor yield and defensive stocks .