A client recently asked why – if the company she held stock in was investing money back into the production of its products – the stock was not going up. My simple response? Because the stock price is determined by supply and demand. If investors do not perceive the company’s actions as something that will favorably impact the company, investors will not drive demand.
What is supply and demand: Each publicly traded company issues a limited amount of shares and shareholders bid against each other for access to those shares. As more people enter the market to buy a stock (demand) rather than sell it (supply), the price moves up. Conversely, if more people enter the market to sell a stock rather than buy it, there is a greater supply than demand and the price will fall.
As I said, this is the simple answer. However, various factors influence supply and demand.
Company specific factors: Any positive or negative developments in a company can directly impact its share price. In the case of the company that has increased production, shareholders should look beyond the company’s investment to the company’s performance. Is the company actually selling the products they are producing, or are the products sitting in warehouses and on shelves waiting to be purchased? If the products are simply collecting dust, investors will not be enticed to purchase the stock. However, if the items are selling in mass quantities, increasing the company’s revenue, then investors will take a closer look and drive up demand for the stock.
Likewise, public announcements about the company’s financials, potential growth, corporate misconduct, a possible merger with another company, and changes in management and leadership can affect shareholder interest in the company, impacting supply and demand.
Market specific factors: Just as news specific to a company’s performance, management, or future prospects can affect the value of its stock price, the general perception of industry and market trends can cause the stock price to fluctuate. New industry regulations, a surge of companies in the same industry, and negative outlooks impacting competing companies can influence supply and demand.
By way of example, Tilray (NASDAQ: TLRY) was the first marijuana company to go public in 2018. Its stock was priced at $17 in the IPO and eventually traded as high as $300 per share. There was a limited supply of shares as most of the company’s stock was held by Peter Thiel’s Privateer holdings. There was also limited availability of other publicly traded cannabis companies for investors to purchase. Tilray’s stock price increased based on the limited supply of Tilray shares and investors’ demand to own a piece of a cannabis company. When other cannabis companies began trading and the lockup for private equity investors expired in January 2019, the number of shares on the market surged and the stock price fell. Today, Tilray trades around $2 per share, a dramatic decrease from its high.
Economic factors: When the economy is booming, companies tend to perform better and see increased profits. Investors look favorably on economic growth and are more likely to invest, causing a company’s stock value to rise. Conversely, when the economy is experiencing a downturn, corporate performance can decrease, alarming investors, causing them to withdraw from the company and the stock price to fall.
Investors may look at the rate of consumer spending, inflation, the GDP, or the government’s stance on interest rates in making their decisions to engage in the stock market. If interest rates are high, corporate borrowing expenses can increase, causing earnings to suffer. Moreover, stocks may be less attractive than CDs, bonds, or other investments whose yields benefit from higher interest rates. Increased interest rates may result in a stock sell-off, causing the prices to fall.
Emotional factors: Let’s face it, at times our investments are made for personal reasons and it’s a bonus if that investment pays off. Maybe you work at a company that is giving you the option to buy shares that you would not purchase but for the ease of the transaction. Maybe you have a sentimental tie to Disney (NYSE: DIS) because you love the company and are an annual passholder. Or, you are so enamored by your Tesla (NASDAQ: TLSA) that you have to own the stock, too. Whatever the emotional reason, you are likely not alone. If everyone who loves Disney jumps in at the same time, the stock price will rise.
Trends (the rise of the meme stock): Over the past few years, we have seen the rise of the meme stock, which thrives on the “fear of missing out” (FOMO) mindset. FOMO fuels a buying frenzy that results in rapid and unsustainable price increases as investors rush to acquire a company’s stock for fear of losing out on expected gains. When a meme stock is identified, usually through social media channels, investors jump in and purchase the stock, manipulating the price in the hopes of making significant profit. This happened with Gamestop (NYSE: GME), which went from about $19 per share to $347 per share in 2021, and AMC Entertainment Holdings (NYSE: AMC), which went from the low teens to $70 per share around the same time. Both companies are trading back in the teens now that the frenzy has passed. Meme stocks are extremely volatile and amount to speculative trading.
Investors should evaluate all these factors when choosing their investments. Even if there are valid reasons why demand for a company’s stock is high, don’t jump into any hasty decisions you may later regret.
Investing involves risks, and no investment strategy can guarantee success. The information provided here is for general purposes and should not be considered as legal, financial, or investment advice. If you are interested in investing, you should seek the advice of a certified financial advisor.
-Written by Lauren Levi