How Stock Prices are Set (Stock Market for Beginners*

0:01 Intro ✅ 0:55 Supply & Demand in the Stock Market ✅ 1:08 Order Book (Bids & Asks) ✅ 2:14 Why Stock Prices Rise & Fall (with examples) ✅ 3:03 Intrinsic Value vs. Market Price: What a stock is really worth ✅ 3:32 Importance of Intrinsic Value ✅ 4:13 How Investors Calculate Intrinsic Value ✅ 4:27 Discounted Cash Flow (DCF) ✅ 5:43 Dividend Discount Model (DDM) ✅ 6:12 Asset-Based Valuation ✅ 6:44 Earnings Multiples (like P/E Ratios) ✅ 7:08 Value Investing ✅ 7:31 Stocks Above their Intrinsic Value ✅ 8:51 Is Intrinsic Value useful? ✅

Stock prices are set by supply and demand in the market, driven by investor sentiment, company earnings, and economic factors. Buyers and sellers set bid and ask prices, with transactions occurring when they agree, often facilitated by an "electronic limit order book". Key drivers include company performance, future outlook, and macroeconomic conditions. 

• Supply and Demand: Prices rise when demand exceeds supply and fall when selling pressure is higher.
• The Process: Exchanges use an electronic limit order book, where, behind the scenes, buy orders (bids) and sell orders (asks) are matched.
• Fundamental Factors: Long-term prices are heavily influenced by a company's earnings, assets, and future growth prospects.
• Role of Sentiment: News, sentiment, and market trends can cause short-term fluctuations, often ignoring a company's true "intrinsic value".
• Macroeconomic Impact: Factors like central bank interest rates, economic policies, and inflation also influence general stock price movements. 

For beginners, understanding that individual stocks are riskier and more volatile than diversified funds is crucial.

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The Myth:
Stock prices aren't set by Wall Street elites in closed doors; they are determined in an open marketplace.

The Mechanism: The Order Book

• The constant change in price is a "numerical battle" between buyers and sellers happening in real time.

• Bids: What buyers are willing to pay.

• Asks: What sellers are willing to accept.

• This live list is called the order book (the market's "secret playbook").

The Current Price:

• The price you see on your app is simply the price of the last transaction where a buyer and seller agreed.

• Key takeaway: The price you see is not necessarily the price you would get if you tried to buy or sell right now.

How Prices Move (The Battle Continues):

• When buyers are hyped: They get aggressive and raise their bids to convince sellers to sell. This creates a "bidding war" that pushes the stock price up.

• When sellers are scared: (e.g., due to bad news) They panic and lower their asking prices to find a buyer quickly. This creates a "sale" effect that pushes the stock price down.

Introducing Intrinsic Value:

• Shifts from the mechanical "how" to the philosophical "why" (Why is a stock worth $5 vs $500?).

• Intrinsic Value: The "real" value of a company based on its fundamentals (earnings, assets, growth potential).

• It represents what the company should be worth if you ignore market hype or panic.

The Core Concept:

• Undervalued: Market price is lower than intrinsic value (potential good deal).

• Overvalued: Market price is higher than intrinsic value (potential wait or sell).

• Crucial Note: Intrinsic value is subjective. It is an estimate, not a fact (unlike weighing apples). Different people analyzing the same company will arrive at different numbers.

Intrinsic Value is Subjective:

• It is an estimate, not a hard fact. Different investors calculate different values for the same company.

Common Methods to Calculate Intrinsic Value:

1. Discounted Cash Flow (DCF):

   • Concept: Predicts the future cash a company will generate and then calculates what that future money is worth today.

   • Why discount? Money in the future is worth less than money today due to inflation and risk.

   • Example: $100 earned in 3 years is only worth about $75 today (using a 10% discount rate).

   • Terminal Value: An estimate of the company’s value beyond the forecast period.

   • Result: If the sum of these discounted cash flows equals $10 per share, but the stock is trading at $8, it might be undervalued.

2. Dividend Discount Model:

   • Focuses specifically on the cash paid out to shareholders (dividends).

   • Useful for stable companies (e.g., utility companies) that pay reliable dividends.

   • You estimate future dividend payments, including its growth and discount them back to today’s value.

3. Asset-Based Valuation:

• Adds up everything the company owns (buildings, cash, equipment) and subtracts everything it owes (debt).

• Works well for companies with lots of physical assets (e.g., real estate firms or banks).

Earnings Multiples (P/E Ratio):

• A quicker valuation method based on comparisons.

• How it works: Take the company's earnings per share (profit) and multiply it by the average multiple of similar companies.

• Example: If tech stocks typically trade at 20x earnings and your company earns $5 per share, the intrinsic value might be estimated at $100 per share.

• Drawback: Relies on comparisons, so it is not always accurate.

Value Investors:

• Investors like Warren Buffett swear by intrinsic value.

• Strategy: Buy stocks trading below their intrinsic value (undervalued) and hold them long-term, ignoring short-term market noise.

• Buffett's analogy: "Investing is like buying a farm. You look at its soil and crops, not what the neighbor paid yesterday."

Why Stocks Trade Above Intrinsic Value:

• Not everyone focuses on intrinsic value. Some stocks trade higher than their fundamentals suggest.

• Tesla Example: For years, the stock price seemed too high based on current profits, but investors were buying for future expectations (growth and new technology), not today's numbers.

Why This Happens:

1. Market Sentiment: Excitement about a company or sector can drive prices up, ignoring earnings.

2. Future Expectations: Growth stocks (tech, biotech) often trade high because investors bet on big future profits.

3. External Factors: Low interest rates (2020–2022) made stocks more attractive than bonds, pushing prices up.

Challenges of Intrinsic Value:

• Hard to calculate for certain companies: Startups or biotech firms with no profits yet have an intrinsic value close to zero based on current earnings, yet their stock price may be high because investors are betting on a future breakthrough.

• It's just an estimate: Intrinsic value relies on guesses about the future (growth rates, economic conditions), which can be wrong.

Is Intrinsic Value Useful?

• Yes, for value investors: It helps find undervalued stocks (buying at a discount). Works great for stable companies like Coca-Cola or Walmart where earnings and assets are clear.

• Less useful for growth investors: They focus less on current intrinsic value and more on future potential.

• Market irrationality: The market can ignore intrinsic value for years—it can stay "irrational longer than you might expect."

Final Reminders:

• Intrinsic value is a useful tool, but it is not perfect and doesn't always work.

• Always do your own research or talk to a financial adviser.

• Investing involves risk; you could lose money.