Over the last week I’ve had a number of conversations with people, both online and off, with some people who seem to believe that volatility in company share prices are nothing more than the manipulations of despotic financial overlords whose sole agenda is to strip wealth from ordinary people and keep it for themselves.
One friend effectively stated that the only reason a company’s share price can halve overnight is because, that company didn’t have the value to start with and that any increased paper value is falsified through the use of financial instruments such as futures contracts.
Given the decimation of wealth that has occurred on a global scale over the last 5 years, it would be easy to believe that a group of wealthy criminals are treating our lives like a game of chance. I’m not saying that volatility isn’t increased by use of derivatives in share markets, I just happen to believe that we should pay more attention to investment fundamentals than conspiracy theories.
With that in mind, I thought I’d share a few examples of how a company’s value, and therefore their share price, can both double over night or alternatively, halve.
It’s important to remember that when you buy company stocks on any listed market such as the Australian Stock Exchange (ASX) that you are buying part ownership of a company. A share of a business. So when a share price goes up or down, it’s a reflection of what the market participants think it’s currently worth. That perceived value will depend on how much information you have access to and what you believe that information really means for the future viability of the company you’ve invested your savings or Superannuation in.
Lets have a look at a couple of commonly reported events that affect sensitivity in company share prices.
- Staff – XYZ Company announces that they are laying off 1,000 staff in a company restructure. The media will often beat this up as an issue of a potentially failing company, and often what happens is a lot of mum and dad investors sell their shares in a hurry, hoping to get out before the company collapses.But what if I told you, that the reason those 1,000 back office staff had been sacked was because new technology advances meant that massive cost savings could be obtained. Then you might think that this improved XYZ company’s long term prospects and decide to buy more shares while other people were selling them cheap. All that buying and selling of stocks creates volatility. The smaller the company, then often the more sensitive they are to both good and bad news.
- Contracts – Ma&Pa Company makes widgets that are sold primarily through their small but well managed website and social media engagement. As a result of their increasing brand awareness, they appear on the radar for Woolworths, who excitedly enter into an exclusivity contract with Ma&Pa to block competition from Coles and IGA.This contract doubles the income of Ma&Pa for a guaranteed 3 years with a possible further 3 years if consumers buy Ma&Pa’s widgets at the expected rate. This increased profitability means the company value is increased for at least the next three years but if for some reason that contract isn’t renewed, then expect the share price to fall to a new level that reflects the new company value. yes, this could happen over night.
- Striking it Rich – GoldDiggers P/L is a small company made up of a group of geology students who, with the financial backing of their parents, started a small business dedicated to prospecting for gold during their Uni holidays. After a small gold seam is found, they list on the ASX via an IPO (Initial Public Offering) to raise more capital to expand their capabilities. With their new funds they lease more specialised equipment and soon after a massive gold deposit is found. Everyone celebrates, including the investors in the IPO who have gone from small prospecting speculators to actual gold producers.
There are a myriad of reasons that affect the price of a company’s stock, and it’s never just conspiracy theories. Please share this post if you think people you know are confused about what drives investment markets.