Forces That Move Stock Prices

Stock prices are determined in the marketplace, where seller supply meets buyer demand. There is no clean equation that tells us exactly how a stock price will behave, but we do know a few things about the forces that move a stock up or down. These forces fall into three categories: fundamental factors, technical factors and market sentiment.

Fundamental Factors
In an efficient market, stock prices would be determined primarily by fundamentals, which, at the basic level, refer to a combination of two things: 1) An earnings base (earings per share (EPS), for example) and 2) a valuation multiple (a P/E ratio, for example).

An owner of a common stock has a claim on earnings, and earnings per share (EPS) is the owner's return on his or her investment. When you buy a stock, you are purchasing a proportional share of an entire future stream of earnings. That's the reason for the valuation multiple: it is the price you are willing to pay for the future stream of earnings.

Part of these earnings may be distributed as dividends, while the remainder will be retained by the company (on your behalf) for reinvestment. We can think of the future earnings stream as a function of both the current level of earnings and the expected growth in this earnings base.

As shown in the diagram, the valuation multiple (P/E), or the stock price as some multiple of EPS, is a way of representing the discounted present value of the anticipated future earnings stream. (To learn about present value, see Understanding the Time Value of Money.)

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