It’s simpler than you think. This article covers an easy explanation on how the stock price is determined and the logic behind it.
Stock (Quoted) Price definition
Let’s start by talking about what is the number that it’s shown when you Google a price of the stock for a specific company, for example Apple’s stock price. The price that is shown there is the price of the latest transaction that occurred. In other words, that is not the price that you will pay for an Apple stock, but rather the price that was paid for the latest trade of an Apple stock.
What what price should you buy a stock?
When you buy stocks, you are technically buying a part of a company. You become a shareholder. For example, let’s say that an imaginary company has 10,000 outstanding stocks, and you decide to buy 10 stocks. You now own 0,1% ((10/10,000) * 100) of the company. Let’s also assume that in the future we believe that the company will generate over $1,000,000 that can be given back to the business owners. This means that each stock $1,000,000 / 10,000 outstanding stocks = $100 / stock.
Those $100 is known as the future value. If you know something will be worth $100 in the future, you will not want to pay more than that nowadays. You will not want to pay $20 to buy a $10 bill, right?
Since we invest in companies to make a gain, we wouldn’t want to pay $100 to buy a stock, because that will mean we have not made any gains. Let’s say that we want to make at least a 5% return on the investment, this means that the price we are willing to make would be: price + 5% price = 100, which is price + 0.05 price = 100, which is price = 100 / 1,05 = 95,2380952381. This value is also known as the intrinsic value.
What makes the price go up or down?
Investors estimate the intrinsic value based on publicly available information, using that value they go to the market and do a bid to try to find a seller that is willing to sell the stock at that price. Once a seller is found and the transaction is completed, the price quoted in the stock market changes to the price of that latest transaction. So the price goes up and down based on the latest transaction that occurred on the stock.
Conclusion
In this article I talked about what makes the price of a stock go up or down, which is simply the price of the latest transaction that occurred in the stock. As you noticed I didn’t talk about why the price that somebody is willing to buy or sell might vary (or in other words, why would the calculated intrinsic value change over time). I will leave this for another article.
