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
In some ways, the stock price is like a measure of the markets view of a company. When the view is positive, meaning the market expects the company to make more money in the future, the stock usually goes up. When the view is negative, meaning the market expects the company to make less money in the future, the stock goes down. This is because the money the company earns (or loses) is passed on to shareholders through dividends, stock, buybacks, or reinvestment into the company. The stock movement in price reflects the view on the company”s future earnings and future value to the shareholder. Now…. the stock may go down, meaning the market believes the company will make less money in the future, for reasons that have nothing to do with the company itself. Look at any one of a number of companies, say Apple, that have been through several drawdowns in the market (the housing crisis, the Covid crisis, the recent interest rate, hikes), and you can see the stock decline significantly. This reflected the markets view that people would buy less Apple products, not that the company was in financial trouble. The stock went down, however Apple did not go bankrupt. When the stock price goes down to the point it is below what many people think is a fair value for its future earnings potential, you will hear people say it is a “value” or “on sale” and buy more, reflecting their confidence in the company.
In your example of Fisker, the stock declined because the market perceived the company would make less money in the future because the company itself was struggling. But the stock decline did not cause the bankruptcy, it was the other way around.
For those not EL5, this is a very simplified explanation, and I’m aware I have not considered other issues, like macro themes, crowding, sentiment, catalysts, etc.
Latest Answers