Friday, February 22, 2013

Excellent Trading School - 3 - Price Factors

Factors that influence the price of a stock?
Broadly there are two factors: (1) stock specific and (2) market specific.

The stock-specific factor is related to people’s expectations about the company,
its future earnings capacity, financial health and management, level of technology and marketing skills.

The market specific factor is influenced by the investor’s sentiment towards the stock market as a whole. This factor depends on the environment rather than the performance of any particular company. Events favorable to an economy, political environment like high economic growth, friendly budget, stable government etc. can fuel euphoria in the investors, resulting in a boom in the market.

On the other hand, unfavorable events like war, economic crisis, communal riots, minority government etc depress the market irrespective of certain companies performing well. However, the effect of market-specific factor is generally short-term. Despite ups and downs, price of a stock in the long run gets stabilized based on the stock specific factors.

Growth Stocks: Companies whose potential for growth in sales and earnings are excellent, are growing faster than other companies in the market or other stocks in the same industry are called the Growth Stocks. These companies usually pay little or no dividends and instead prefer to reinvest their profits in their business for further expansions.

Value Stocks: The task here is to look for stocks that have been overlooked by other investors and which may have a ‘hidden value’. These companies may have been beaten down in price because of some bad event, or may be in an industry that's not fancied by most investors.

However, even a company that has seen its stock price decline, still has assets to its name - buildings, real estate, inventories, subsidiaries, and so on. Many of these assets still have value, yet that value may not be reflected in the stock's price. Value investors look to buy stocks that are undervalued, and then hold those stocks until the rest of the market realizes the real value of the company's assets. The value investors tend to purchase a company's stock usually based on relationships between the current market price of the company.

Dividend yield is calculated by aggregating past year's dividend and dividing it by the current stock price. For Example:
ABC Co. Share price: Rs. 360, Annual dividend: Rs. 10, Dividend yield: 2.77% (10/360)

Historically, a higher dividend yield has been considered to be desirable among investors. A high dividend yield is considered to be evidence that a stock is underpriced, whereas a low dividend yield is considered evidence that the stock is overpriced. 
A note of caution here though. There have been companies in the past which had a record of high dividend yield, only to go bust in later years. Dividend yield therefore can be only one of the factors in determining future performance of a company.

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