A:

Contingent liabilities are likely to have a negative impact on a company's stock share price because they threaten to reduce the company's assets and net profitability. The extent of the impact on share price depends on the estimated probability of the contingent liabilities becoming actual liabilities.

Stock prices are affected by overall economic conditions and market movement, but primarily by a company's financial health and profit performance. One factor that can affect share price is contingent liabilities. Contingent liabilities are liabilities that a company may or may not incur, depending on the outcome of future events. Examples of contingent liabilities include pending lawsuits, possible fines by government regulatory agencies, and income or sales tax adjustments or fines that have not yet been determined.

Contingent liabilities differ from fixed liabilities. Fixed liabilities are a known financial obligation of the company, such as interest payments on financing or mortgage payments.

Due to the nature of contingent liabilities, it is difficult to assess the exact impact that they may have on the company's stock price. If, for example, the company is facing a lawsuit, the end result may be a small liability, a very large liability or no liability at all. Since it is impossible to know the outcome in advance, and due to the fact that there may be no resulting liability at all, companies often do not mention such potential liabilities on their balance sheet. It is more common for contingent liabilities to only be mentioned in notes or footnotes on a company's financial statements. An exception that requires direct inclusion on financial statements is a liability that has an estimable value and a greater than 50% probability of being realized.

The opinions of market analysts are divided on the impact that contingent liabilities have on share price. Some analysts argue that, regardless of any contingent liabilities, a company's share price will still move in concert with revenues, profitability, growth and return on equity (ROE). Other analysts contend that contingent liabilities do have an impact on share price because they represent a significant potential threat to investors' profits. However, even analysts who argue that there is an effect on share price admit that there is no exact way to quantify the extent to which contingent liabilities may be factored in to existing share prices.

The determining factors in the possible impact on share prices are the probability of the liability actually being incurred by the company, the estimated potential amount of the liability and the time frame over which the liability may remain contingent. For example, a contingent liability from a lawsuit that is expected to be settled within days is much more likely to have an impact on share price than an outstanding lawsuit that is not expected to be settled for several years.

If a company is evaluated as having a strong cash flow position, little debt and rapidly growing earnings, then investors may be inclined to discount contingent liabilities – in effect, deciding that the company's financial health and performance will be sufficient to overcome any such liabilities and continue to make the company a profitable investment.

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