It sounds like a obvious question but hear me out. Yes, I understand why stock price and how a company performs have a direct correlation. I do also understand that a company’s performance affects its stock price. However, I do not understand the other way around, especially when the shares crashes.
This is my understanding how stock works: when a company goes public, the company raises money from the public in exchange to the ownership of the company. Stock price going up doesn’t mean the company gains more money as the investment is already made. Stock price going down doesn’t mean it looses money as they do not have to pay back for the investment. So why do companies go bankrupt due to its stock price crashing (and possibly get delisted)?
In: Economics
Stock price X total outstanding shares = the entire company’s value.
The company itself can always issue more shares to sell. When you issue one additional share and sell it at say $100, the company now has $100 of cash but the total valuation in that instant remains the same. This is how public companies “raise money”. It is also important to note that when doing this, all the pre-existing shares represent a little bit smaller fraction of the company than before that one new share existed, so the stock price will naturally drop a little bit.
Now that we understand that, the “company doing poorly” and “stock prices crash” is just a chicken and egg cycle. Company not generating good profit = company is worth less = stock prices drop. Company losing money also means that the company need to raise money. But if the stock price is low, it’s harder to raise money by issuing more stocks, so the company is even further screwed.
Latest Answers