20 August 2011

The Explainer: Stock Market - Part III

About an hour ago, the courier guy delivered a parcel containing a copy of Monsoon by Robert Kaplan. Geopolitics and geostrategy have always fascinated me; in fact, along with history, philosophy, and literature, I just love these two ideas. 

I will keep this post short, that is because I am eager to start reading the panoramic sweep of ideas that this book promises. In this week's The Explainer, I will focus on factors that influence share price. 

What factors influence share price?

The major factors are:
(a) company performance & dividend income;
(b) speculation;
(c) industry prospects, and
(d) government policy.

(a) Company Performance & Dividend: 
Investors often keep an eye on a company’s performance, especially with regard to its earnings. Often, you must have observed that your investor-parent / uncle / sibling or simply any player in the stock market pays great attention to the declaration of the company’s earnings (quarterly or half-yearly or annual).

If a company is running profitably, investors would definitely show interest in owning shares of such a company. As the business churns out profit, it may reward its shareholders with rising share prices.

Also, some investors buy shares with an eye on dividend (distributed profit; return on investment in shares). When the company declares dividend, it distributes the profit among the shareholders. A company that declares dividends on a consistent basis will attract investors.

However, there is demand from investors even if the company does not declare dividend. Thus is because if the company does not declare dividend, it would convert the profit into cash reserves, which can be used to buy other companies, invest in better technology, and to ride over rough market times.

For example, Apple Inc. has not declared a dividend since 1995! It is sitting on a cash pile of U.S.$75 billion. Its share price has gone by more than four times in the last four years. I think you have got the point.

(b) Speculation
In India, most people invest to reap a profit in the short term, and not to maximize the value of their capital appreciation in the long run. Given the nature of India’s stock market, speculation is the norm, not the exception!

Speculation can lead to volatile movement in share price, even in a short time. A few years back, in a mail to a student I explained speculation in the following manner:

You buy the shares of Company A because you believe somebody else will pay more for it in the future. Now the reasons for the expected price rise do not really matter. All that matters is the belief that the share price will rise. Such speculators (short-term traders) don’t base their buying behaviour on factors like company performance. Most bubbles in the stock market are the result of large-scale speculative trading. It is in the nature of a bubble to burst, and when it bursts, it takes with it a large number of speculators down the drain.

In the same way, a company’s poor performance, poor earnings outlook, missed dividend payment, or even speculation can drive its share price down. 

(c) Industry Prospects
Another major factor that plays a major role in determining the share price is the industry outlook. Investors (am not talking of speculators) like certainty; stability is good for business. The nature of business environment often determines the growth of an entire industry. 

For example, the current outlook of the U.S. and Eurozone economies is pessimistic and negative; these are the major markets for the IT and ITeS (IT-enables Services, like BPO) sectors. Now if the clients in these markets scale down their deals with Indian companies in these two sectors, the latter's performance will also suffer. This will, in turn, impact the revenues, profits, and overall business. It is these negative factors (i.e. downturn and fears of recession in the U.S. & Eurozone economies) that have brought down the share prices of IT companies in the last few weeks.

(d) Government Policy
Government policy can also play a vital role in influencing share prices. The government's has a positive attitude toward a particular sector / industry can help send positive signals to the investor community. Government incentives may include tax holiday and supply of land and power at concessional rates.

For example, if the government gives tax holiday (no tax payment for a specific number of years) to companies in a specific sector, then the company need not pay tax, thus saving precious money and build reserves or pay dividend. 

There is another major factor: the company's performance against its peers. But I will stop here. Monsoon is waiting for me! Thank you!

(Please select your reaction to this post; see below.)


hemanth said...

Nice post sir...:)

Rohith castelino said...

This is an extremely well written article, And I would love to read more on this topic SHARES, "Sir you have really enlightened my awareness about SHARES, A sincere request to you please publish 4th part I am eagerly waiting"
Thank you very much for all the 3 parts.

ramya said...

Sir thank you very much for the information eagerly waiting for the next part

Ravi said...

Thanks for the info Sir. For a first timer like me just can you add the link of part 3 at the bottom of Part 2 so that we can start from the start till the end :)

Revathi said...

Thank you, sir. You made it very easy and interesting to understand!

Arpit Agarwal said...

sir please tell something about FII and how it is different from FDI.... thank you sir for such helpful information.

Unknown said...

very nice explanation sir.......

D Dinesh Chand said...

When the company doesn't pay dividends what is the point??? why do people buy the shares when there is no return on the shares??

dream said...

Hi, please correct me if I'm wrong. Dividends are nominal returns which can be obtained by investing in less risky assets also. whereas sharemarkets are intended for higher returns. People largely invest expecting the price of inherent share to go up and making good profits. Hope it explains.
Sir, correct if I'm wrong on the same.

Akshay Dhabekar said...

Thank you very much sir for sharing such information about stock markets. Very well elaborated to understand the actual tactics about how the global market is running with the capital distribution and building.
thank you.

Anonymous said...

Thank you very much Sir for such elaborative and informative articles.
Please continue with this series! :)

Anonymous said...

Thnak you sir
short and crisp => pleasure to read and understand

Anonymous said...

sir, I have a doubt. In case of a company gaining profits and it deciding not to pay the dividends, how does the share value rise? Is it just because of market factors or is it because of profit adds up to the capital value of the company and it reflects in the rise in par value per share?

sudheer said...

Sir,I read all the three parts.It was explained in a very simple way.Thanks a lot.Sir,Please post the 4th part.I am eagerly waiting for that one.

Anonymous said...

sir, how the share value rises or decreases by a certain amount and that too it varies daily ,how it is decided and by whom it is decided ?

Unknown said...

sir,why would someone invest into a company which hasn't declared its dividend wouldn't that involve a lot of risk? how will the investor get any profit from the company?

Unknown said...

Sir can you explain something about sensex also. I dont anything about it.

Navs! said...

To the people who asked Bharath why we should invest on companies that do not declare dividend:

A company may not pay a dividend if its directors believe that it's better to put the business's profits to work making the business itself more valuable. The best example is Warren Buffet's Berkshire Hathaway. In the last 20 years of this company's existence, not a single penny has been paid out as dividend. Instead, the company reinvested the profits into other investments. If company's assets increase, the share value of the company too increases. For long term success, investing in such well-established businesses is the best idea.


Unknown said...

Sir, sometimes i observed that shares of a company are down even after posting decent quarterly results Is there any logical explanation for that?

Anonymous said...

Thank you so much sir.

Unknown said...

Thank you sir.