Understanding Stock Price
In the “A - B Computers” example, each founder invested $200 and received 200 shares with a present value of $1 each. If John leaves the company a month after it was founded, and sells his portion of the company to a new partner, he will probably receive about $1 per share - a total of approximately $200.
However, if the company discovers an oil reserve under its warehouse, new investors will be willing to pay $8, $10, or conceivably $1 million per share. The stock value, not necessarily stock price depends upon how much investors expect the company to earn from its newly discovered oil.
On the other hand, if the company is on the verge of bankruptcy, it is quite possible that nobody will be willing to pay even $0.01 for the stock. This example clearly shows that there is no relationship between the par value of a stock and its actual stock price.
How is Profit Earned on a Stock
If “A - B Computers” stock is purchased at $1 per share, and the company is awarded a lucrative contract two days later by the US government, or if the company unveils a new, powerful computer program causing the stock price to jump to $2 a share, shareholders would make a profit.
If, on the other hand, the company loses a contract, or a new competitor enters the market causing the stock price to fall to $0.50, shareholders would lose money.
Factors that Affect Stock Prices (a Preliminary Discussion)
The major factors that affect stock prices are as follows:
Profitability - the more profit that a company earns, or the greater its chances of achieving future gains, the more people will be willing to pay for its stock.
Property - the more property that a company owns, and the less debt it has incurred, the greater its value and the more its stock will be worth.
Management - if a company’s management has proved its worth in the past and investors are confident that management will lead the company to success, then the stock price will go up.