Table of Contents
Understanding capital markets
What determines stock price?
What factors can affect stock price?
The bottom line
Jun 21, 2022
6 min read
The price of a stock is determined by supply and demand. If more people want the stock than the number of shares available, the price goes up.
The stock market, or Wall Street as a whole, may seem inscrutable: What does it mean to own a share of a company? Who sets stock prices? And why do stock prices change every second, or seem like they do?
Supply and demand determines stock prices. But that simple statement belies all of the considerations that go into each side of the equation. Stock prices can change for a variety of reasons, from events specific to the company to broader forces impacting the market as a whole.
To understand how share price is determined, it’s helpful to step back and consider what it means to buy a stock.
Companies issue stock to raise money to run their businesses. Investors who buy those units of stock, called shares, are buying a little piece of the corporation that issued the shares. The number of shares available depends on the individual company.
People who own shares can vote on issues proposed in shareholder meetings, and they may receive a portion of profits in the form of dividends, if that’s something the company offers. And shareholders can sell their shares—ideally at a higher price than they paid so they make a profit. These investors don’t own or manage the company itself.
Now, let’s take a broader look at how stocks function by discussing the fundamentals of capital markets in general.
When companies first choose to sell stock publicly, they work with banks to underwrite the deal. This first issuance of the stock is called an initial public offering, or IPO. The investment banks and the company determine the per-share pricing of the IPO, and this first issuance of shares is sold directly from the company to investors—often including a lot of institutional investors like mutual funds and pension funds that trade large amounts of shares.
Companies can also use this market to issue bonds, a sort of loan deal in which the investor will receive the amount of the loan, plus a bit of interest after a given amount of time. And once they’re publicly traded, companies may use this market for a “primary issue” of a new round of stock or bonds.
The primary market is where the stock or bond is created when it’s first issued, and sold directly from the company to the investors. But after that, the investors need a place to trade, which is where the secondary markets come in. These are the various exchanges where a stock can be listed—major ones include the New York Stock Exchange and the Nasdaq in the US, the Shanghai Stock Exchange in China, and the Japan Exchange Group.
The secondary markets are what the stock market or Wall Street looks like to most people. It’s where retail and institutional investors can buy and sell their holdings. That buying and selling is what can send individual stock prices higher or lower.
To put it simply, the price of a stock is determined by supply and demand. If more people want the stock than the number of shares available, the price goes up. Conversely, when lots of people are looking to sell their shares, the price of the stock falls. If an investor sells when the stock is higher than the price they paid, they make a profit. If they sell when the stock is down—as investors might for a variety of reasons, including fears that the stock will head even lower in the future—they could lose money.
Those stock sales happen when a market maker facilitates deals between buyers and sellers. Would-be buyers share the price at which they would be willing to purchase a stock, called the bid, and sellers share the price at which they’d sell. When those prices match up and a deal can be made, the market maker completes the trade—and that becomes the market value of the stock.
It’s this buying and selling between investors that ultimately determines the price of a stock. But how do investors decide whether to buy, sell, or hang on to their shares? There’s no magic stock price formula, but rather multiple factors affecting share prices in the stock market.
News and events happening at the company specifically, as well as the country or the market at large, can affect stock prices.
First, it’s key to look at the company’s “fundamentals”: its financial performance now and its expected performance in the future. This includes information like the company’s earnings, sales, and outlook, which are shared publicly in quarterly financial reports, along with details like customer growth, cost-cutting measures, and other factors. Investors want to see the firm meet or beat analysts’ expectations on financials, and to issue a rosy outlook for future quarters.
Analysts and investors alike evaluate if the current stock price is fair, undervalued, or overvalued in part by looking at considerations like the price-to-earnings (P/E) ratio. Also known as the price or earnings multiple, this ratio divides the company’s current stock price by its earnings per share. A high P/E ratio might make investors feel the stock price is getting ahead of itself and should come down—or they might feel comfortable with it if they expect good future results. A low P/E ratio could mean a stock’s price is low relative to earnings and might be a place to buy. This ratio also helps investors make easier comparisons to other stocks.
Other company news and events that could affect stock price include executives arriving or leaving, regulatory probes, and landing (or losing) a big customer.
Another major category affecting stocks is technical analysis. Some investors, including institutional ones, use stock price algorithms, statistical patterns, charts, and other data to execute a deeper analysis that attempts to predict future stock moves.
There are also plenty of events that happen outside of the company, yet could still impact its financial performance—or the perception of its value. A new administration with a more permissive regulatory stance, in general or for a company’s specific field, could be seen as a boon and send the stock higher. Inflation is an economic data point always in focus. Geopolitical tensions and natural disasters can affect shipping routes or oil production, which can trickle down to have an impact on companies in many industries.
General market sentiment can also play a significant role in stock prices. During times of economic crisis, like the Great Recession of 2008 and the Covid-fueled market downturn in 2020, the stock market in general tends to decline. Institutional investors making big moves into a certain part of the market could kick off a trend that gets other investors piling in too.
At the most basic level, the factor that determines stocks’ prices is supply and demand. Buyers and sellers trading via the market set the price. However, there are complex considerations of both the company’s performance and broader market forces that can affect that supply and demand.
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