Wednesday, 22 February 2012

Security Prices Move Up and Down for Two Basic Reasons: Business Reality or Supply and Demand

Security prices move up and down for two basic reasons:
  • to reflect business reality (or investor perceptions of that reality) or 
  • to reflect short-term variations in supply and demand. 

Reality can change in a number of ways,
  • some company-specific, 
  • others macroeconomic in nature. 

Company-specific factors
  • If Coca-Cola's business expands or prospects improve and the stock price increases proportionally, the rise may simply reflect an increase in business value. 
  • If Aetna's share price plunges when a hurricane causes billions of dollars in catastrophic losses, a decline in total market value approximately equal to the estimated losses may be appropriate. 
  • When the shares of Fund American Companies , Inc., surge as a result of the unexpected announcement of the sale of its major subsidiary, Fireman's Fund Insurance Company, at a very high price, the price increase reflects the sudden and nearly complete realization of underlying value. 

On a macroeconomic level

These factors could each precipitate a general increase in security prices:
  • a broad-based decline in interest rates, 
  • a drop in corporate tax rates, or 
  • a rise in the expected rate of economic growth.

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