Why stocks go up and down? from book “Why Stocks Go up and down”
With the understanding of the P/E ratio, price/cash-flow ratio, and EV/EBITDA ratio, and how stock prices anticipate future events, we can now attempts a working explanation of Why stocks go up and down.
- Why stocks go up and down in response to changes in perception of a company’s ability to generate earnings and pay dividends, both this year and in the future.
- changes in perception can arise from developments within the company, in the company’s competitive environment, or in the economy in general.
small tips
- for small, rapidly growing companies, or for mature dividend paying companies, it is the long term growth and free cash flow that drives stock prices.
- The anticipation by the market is a key concept that investors must understand
- The upside or downside from an earning surprise is more significant for debt-laden companies. In other words, a highly leveraged company that beats consensus will ilkely see their stock go up significantly. This is because with improved earnings, the debt service requirements (interest and principal repayments) become more likely to be met. conversely, the stock of the same firm would likely be punished if earnings miss consensus, because the company would be closer to a point where it might be unable to meet its debt service and would go into default. Investors should be particularly cautious with highly leveraged (high debt) companies around the times when earnings are expected to be reported.
Events creating favorable or unfavorable changes in perception
- company development
- industry development
- economic development
By watching how stock prices respond, or do not respond, to news developments over a period of time, you will develop an awareness of
- what expectations are reflected in a stock’s price
- which information will likely impact future earnings
- what the current sentiment of the market is toward the company and industry it operates in.
To develop this awareness, investors should read/listen to the news daily, review industry periodicals, and peruse website and blogs that relate to their stocks and investment style. Alert investors will watch for developments that could affect their company in a positive and negative way, including the demand for their company’s products, the price the company can charge for its products, the cost of manufacturing the products, and so on.
