The stock market operates based on the principles of supply and demand. Buyers and sellers determine stock prices through their transactions. Let’s delve into the details:
Initial Public Offering (IPO):
When a company goes public, it works with investment bankers to set a primary market price. This price is based on valuation and demand from institutional investors.
After the IPO, the stock starts trading on secondary markets (such as the New York Stock Exchange or Nasdaq). Here, the market acts as a voting machine.
Buyers and sellers continuously bid and ask for new prices. If more buyers exist, the price rises; if more sellers, the opposite occurs.
Law of Supply and Demand:
Stock prices follow the law of supply and demand. The price reflects what current buyers are willing to pay and what sellers are willing to accept.
This principle applies to any commodity: the price is determined by supply and demand.
Long-Term Valuation:
Over the long term, stock prices are influenced by the earnings power of the business.
A stock represents a share of an actual business. The better the business performs, the better the stock does.
Billionaire investor Warren Buffett believes a stock’s value is the discounted value of future cash flows it will earn over the business’s life.
Valuation Methods:
Absolute Valuation: Models like the dividend discount model (DDM), discounted cash flow (DCF), and residual income model estimate intrinsic value based on fundamentals.
Relative Valuation: Compares the company to similar ones using multiples (e.g., price-to-earnings ratio) to assess relative value.
Undervaluation and Overvaluation:
If a stock trades below its intrinsic value, it’s considered undervalued.
Conversely, if it trades above its potential, there may be hidden risks associated with the firm.
Remember, stock prices fluctuate due to various factors, including company performance, market sentiment, industry trends, and macroeconomic conditions123. 📈📊
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