All in all, share prices aren’t just prices moving up and down, up and down. They are a reflection of a company.
If you were interested in buying your local corner shop, you’d look at things such as management, if profits were improving and if there were competitors taking away market share.
Shares are essentially a share in a business and while it may not be your local corner shop, the concepts are very similar.
Underlying drivers of the business are important
Here’s what famous investor Peter Lynch has this to say to investors:
“Well, they should think about what’s happening. I’m talking about economics as forecasting the future. If you own auto stocks you ought to be very interested in used car prices. If you own aluminium companies you ought to be interested in what’s happened to inventories of aluminium. If your stocks are hotels, you ought to be interest in how many people are building hotels. These are facts.”
The point of the story is that investors should be aware of the underlying drivers which help or hinder a business.
Watch economic events closely
If an economic event shows a business environment that is favourable to companies making profits and growing, you’ll usually see a positive reaction from share prices.
But if the economic event shows that company profits may fall, you will generally see share prices come under pressure.
If interest rates are low, employment high, consumer confidence high, then it will be relatively easy for businesses to make money.
But if interest rates are rising, employment is low. People then stop spending money and businesses make less profit. So share prices fall.
Market sentiment is important too
The share market is like any marketplace. If there are more buyers then sellers then prices will rise.
And if there are more sellers than buyers prices will fall.
Buyers drive up the price and sellers drive down the price. A perfect example of this is at the seafood markets. Normally prawns sell for around $ 25 a kilo. At Christmas time, prawns sell for about double. Why the big difference? At Christmas, the large number of buyers drive up the price of prawns. The seafood market, like the sharemarket, sees buyers drive up the price and sellers drive down the price.
In the end, the sharemarket is simply a market full of businesses. In the long-term, share prices are a reflection of the value of the underlying business.
You’ll find that businesses that increase their profits increase their business value and share prices should eventually follow suit.
Juli Alee is an Equities Analyst for online share trading platform Bell Direct. Julia provides information on share trading and stock market research for frequent traders and investors.