Publicly traded companies place great importance on their stock share price, which broadly reflects a corporation’s overall financial health. As a rule, the higher a stock price is, the rosier a company’s prospects become.
Analysts evaluate the trajectory of stock prices in order to gauge a company’s general health. They likewise rely on earning histories, and price-to-earnings (P/E) ratios, which signal whether a company’s share price adequately reflects its earnings. All of this data aids analysts and investors in determining a company’s long-term viability.
- A company's stock price reflects investor perception of its ability to earn and grow its profits in the future.
- If shareholders are happy and the company is doing well, as reflected by its share price, the management would likely remain and receive increases in compensation.
- The prevention of a takeover is another reason that a corporation might be concerned with its stock price.
- If a company's stock price is performing well along with the company, the company is likely to receive more favorable press from analysts and the media.
Most companies receive an infusion of capital during their initial public offering (IPO) stages. But further down the line, a company may rely on subsequent funding to finance expanded operations, acquire other companies, or pay off debt. This can be achieved with equity financing, which is the process of raising capital through the sale of new shares. However, for this to happen, the company must demonstrate a healthy share price, in order to project an attractive outlook to potential new investors.
A company should be careful not to over-issue new shares, however, because an overabundance of shares out in the market may diminish demand, where there’s simply not enough buyers to gobble up the shares, which could ultimately depress the stock price.
Furthermore, creditors favor companies with higher-priced shares, which typically correlate with a company's earnings. Such healthy companies are better able to pay off long-term debt, which usually means they’ll attract lower-interest-rate loans, which consequently strengthens their balance sheets.
Performance Indicator of Executive Management
Since a company's share price is often used as an indication of the overall strength and health of the company, as the stock price climbs over time, the management is considered to be doing a good job. If shareholders are happy and the company is doing well, as reflected by its share price, the management would likely remain and receive increases in compensation. However, if the company is not performing well and the share price is declining, the executive management is at a high risk of being removed by the Board of Directors, who are elected by the shareholders. In short, if shareholders' returns are unfavorable and the share price lags, management would likely be removed.
Compensation is another important reason for the management of a company to keep the stock price as high as possible. Executives may receive part of their compensation in the form of stock options, which gives them the right to purchase shares of the company at a future date and a set price. Over time, for the option to gain in value, the stock price would need to rise. Issuance of stock options to executives is an incentive to align the interests of the executives with the overall business strategy, and the shareholders.
Risk of Takeover
The prevention of a takeover is another reason that a corporation might be concerned with its stock price. When a company's stock price falls, the likelihood of a takeover increases since the company's market value is cheaper.
Shares in publicly traded companies are typically owned by wide swaths of investors. Therefore, bidders who seek to take over a company by obtaining a majority of shares, can more easily afford to do so when the stock is trading at a lower price. Consequently, management strives to keep the share price high, in order to discourage this activity. Conversely, a company whose shares trade for high prices are better positioned to take over a competitive interest.
Companies with high share prices tend to attract positive attention from the media, as well as from equity analysts. The larger a company's market capitalization, the wider the coverage it receives. This has a chain effect of attracting more investors to the company, who infuse it with the cash it relies on to flourish over the long haul.