It can be scary for investors when they purchase a stock and see it go up and down in price.
Fear of volatility is especially true if they do not understand why stock prices move up and down.
We first need to define what investing in a stock is.
When you invest in a stock, you invest in an actual company. A share of stock is equal to ownership in that company. Some think owning a stock is just gambling on random stock symbols. This misconception couldn’t be farther from the truth!
Source: Fox Business
It would help if you remembered that a share price can move every few seconds due to the supply and demand in the market. Therefore, when a stock price goes up and down, the price that investors are willing to pay to own a piece of the company changes.
With that in mind, we will go over seven reasons why stock prices go up and down!
- Market Correction
A stock market correction happens every 8-12 months and lasts about 54 days.
When this happens, it’s generally due to the market being overvalued during this period, and investors continue to sell at lower prices as expectations come down to reality.
This one seems obvious, but it is tough for people to grasp now.
We tell people to look at it like this:
The stock market has averaged 10-12% yearly since 1957.
If the stock market has a year where it averages +30%, what needs to happen?
We will get a down year soon to keep the 10-12% average.
If the stock market has a year where it averages 30%, guess what needs to happen?
We will get a big up year soon to keep the 10-12% average.
This activity is a simple and recurring market correction.
- Earnings Report
Publicly traded companies in the U.S. must publish earnings every quarter of every year.
Earnings reports provide transparency between the company and the business.
Wall Street analysts come up with their estimates about a company’s performance, which are usually guided by the company’s corporate development team.
If a company beats expectations, the stock price will go up.
However, if a company fails to meet these analysts’ estimates, the stock price could get hammered in the short term.
Source: Investopedia
- Dividends Changes
Dividends are payments given to shareholders in the form of profits.
These payments are not mandatory and could increase, decrease, or eliminate at any time.
If a dramatic change happens to the dividends, the stock will have a positive or negative impact!
For example, if a company cuts its dividends, it could struggle with its cash flow. They can only pay the dividends if they have extra cash. In most situations, lowering the dividend causes the stock to go down!
If a company raises its dividends, this usually means the company is in great financial shape. Increased dividends would be a reason that the stock goes up.
However, sometimes, companies raise a dividend even when they can’t afford it. If a large number of people realized this, then it would cause the stock to go down.
- News on Products/Services
Information and news surrounding the products and/or services a publicly traded company offers almost always impacts the share price.
As an investor, you should always pay attention to any product/service releases and recalls for companies you invest in.
Based on your knowledge of the situation and the company, you ultimately want to decide whether a product/service release or recall gives way to more buying opportunities or acts as a warning sign for poor management decisions.
For example, Chipotle’s stock crashed when there was a major recall of their lettuce due to E. coli. The news went viral, so people started selling Chipotle stock.
However, the company’s financial health and core business model stayed the same. Chipotle’s issue was a temporary public relations problem that many slowly forgot. Instead of selling your stock, the best decision at the time would have been to hold the stock and purchase even more at a discount. The stock has doubled since this “scandal.”
- Acquisitions
If one company acquires another, it almost guarantees that the share price will also move. Usually, this is good news for investors, but you can never say this for sure.
The stock acquired will usually go up.
For example, if the stock trades for $10 and is acquired for $30, it will go way up.
However, this may differ depending on how investors feel about a particular acquisition.
For instance, if a company with much debt acquires a company with even more debt, even if the acquisition appeared to be strategic, investors will likely not be happy with the company taking on additional debt.
- Management Changes
If Elon Musk left Tesla, what would happen to Tesla stock on the announcement? It would likely go way down.
Source: Elon Musk
If Elon Musk became the CEO of a random company, what do you think would happen to that company’s stock? It would go way up.
With a strong management team, a company will retain its competitive advantage over time, and its share price will likely stay high.
When a company’s management changes, the stock price will move somehow.
Management changes are often positive for investors, but this is not always true.
- Other Bad News
Several other adverse news events can cause the share price to fall fast. News like this would include scandals, accounting errors, SEC investigations, data breaches, and more.
Based on this bad news, You have to look at the situation and determine whether you want to be a shareholder.
One example of this is the Facebook-Cambridge Analytica scandal in 2018. Cambridge Analytica, a political data analysis firm, exploited Facebook and got hold of a massive data set of the American electorate without their permission.
Due to this scandal, Facebook’s market value fell by more than $36 billion. However, after this scandal blew over, Facebook was back to trading at “normal” levels.