how does a company’s profitability really affects its share prices?

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As far as I understand, the only thing that investor really get from the company’s profit is mainly from dividends. So, all other P/E ratios, fundamental analysis, chart analysis, etc for stock price growth are no better than just looking into a fortune-teller’s crystal ball? Stock prices seems to be almost entirely driven by “market forces” aka what people feel about the company. Whatever those “expert” analysts say seems to be just trying to put meaning into something that really doesn’t actually impact the stock price, not much difference from horoscope? There are many big profitable companies with almost flat stock prices and there are also companies without any real profits but the stock prices skyrockets.

In: Economics

8 Answers

Anonymous 0 Comments

Professional analyst here,
It looks like some of the confusion is about short-term vs. long-term price movements. Some people who believe markets are “efficient” would suggest that the two are very strongly related. A relationship exists, but it isn’t that strong. So what you really need is four parts:
1. Do earnings matter to the short term price?
2. Why?
3. Do earnings matter to the long term price?
4. Why?

1. Quarterly earnings reports have a material impact, but the even larger impact comes from management’s guidance for future earnings.

2. The short term price is very heavily impacted by sentiment. If investors are optimistic, the price goes up, pessimistic and the price goes down.

3. The long term price is still driven by expectations, but it is also anchored more by reality. Let’s take an example. If we can look at a business and be very confident it can continue to cover the dividend and raise it every year, we could start estimating the value of the current payment plus the future growth. This is the arguably the most basic part of analysis.

4. This concept gives people so much trouble, but it is critical to understand. If you owned 100% of a business, all you would care about (in a profit seeking manner) is how much cash it could give you over time. “Earnings” are similar to that cash flow. There are differences, but this is ELI5. So if you are planning to invest for the long term, you want to know how much you are paying today and how much the company will be able to generate for you in each year in the future. Further, you would want to estimate the risks of being wrong. If things don’t go how you expected, how much better or worse might they be?

Your best bet is to learn these parts completely before trying to tie in anything else.

Pretend you would be holding the stock forever. If you plan to sell it in the future, ask yourself what would cause you to buy it in the future instead. Many investors don’t look through the eyes of the other person in the trade. It is a critical mistake. When I’m buying a stock, I want to understand what could go right and what could go wrong. If I see a great deal, why is the market (collective group of all investors) willing to accept that price today?

PS. This was probably more of an ELI12.

Anonymous 0 Comments

When you have stock in a company, you own a small portion of the company and ultimately all profits belong to the owners. Many companies pay a dividend which is a payment out to owners from their profit each year. Companies that do not pay out a dividend hold onto their cash or reinvest it into growing the business, but will likely find ways to return money to shareholders in the future through other means such as a share buy back.

Anonymous 0 Comments

Well if you bout stock at 1dollar a year ago, and today published its accounts and it’s made say 400% more than expected, your share is prob going to go to say 2dollars even though you may only get a 10cent revenue so if you choose to sell your share price had made 10times more than the dividend.
This is super over simplified btw.

Anonymous 0 Comments

If you’re 5, I’d tell you that a company which is making more money is worth more money. That’s because companies that are making a lot now, are probably going to make a lot in the future too. It shows that they’re doing a good job.

-Professional stock trader

Anonymous 0 Comments

The price of a stock (or anything) is simply what people are willing to pay for it. No one sets the price, apart from the IPO where an investment bank will, and it’s hard to do. You can try and figure out the rationale for why something is priced a certain way but it’s a fools errand imo, it just comes down to whether people are buying it. Why are they buying it at $X? Who knows, but they are, and the price will stay there until they stop, in which case the price will go down until people start buying again.

Anonymous 0 Comments

Shares tend to trade at a ratio of profits called P/E ratio (price/earnings). Market average is about 15, but that varies based on company industry, growth prospects, etc. So as profits grow, a company’s share price would grow assuming stable P/E for that company. A slow growth or declining industry (utilities) will see lower P/E than a high growth sector or company (Tesla). It’s as much about predictions of future as it is past results, so a company losing money today that is projected to hit profitability and large growth in the future will trade at higher P/E than hugely profitable but stable company.

Anonymous 0 Comments

Stocks don’t JUST pay out dividends, they also (depending on the stock) may provide a vote at shareholders’ meetings and elect the company’s board of directors, though it varies by company if there’s any value here. Often some single shareholder (individual or company) holds 51% of the stock and hence automatic vote winning power.

Stock prices are valued at what people will pay for them. If you can offer your stocks for a 10% purchase mark-up and someone accepts that deal and purchases them, good for you! Whatever their decision making process is, you just profited from it.

A companies’ profitability *should* be a big decision maker in people’s stock choices, but it doesn’t *need* to be, plus it doesn’t have to be TODAY’S profitability. Buying stock when it’s cheap and holding onto it for the big(ish) dividend payouts starting in 3 years may be a reasonable strategy to someone willing to play the long game. Of course, now it’s all speculation and how much the stock is worth, and whether in 2.5 years time it’s worth selling at a profit to someone else.

So, if you find out where those fortune tellers get their crystal balls, let me know!

Anonymous 0 Comments

ELI5: it doesn’t.

There’s no basic answer as to why. So many factors influence share prices:

– company performance, and it’s performance relative to the market
– perceived riskiness of the market / operations / strategy
– dividend policy
– external factors (tax policy, returns on bonds and risk-free assets etc)
– utter nonsense (ie analysts simply not understanding the market and believing what they are told / have read etc)

The stock market is a fool’s game. The top performing fund managers are never consistent one year to the next. It’s possible to consistently “do well” but there are no guarantees and the higher the stakes, the less likely the consistency of performance