🎯 In 30 seconds: A price moves when buyers are more eager than sellers, or the other way round. Underneath that, a share is worth the profits the business will make in the future, so prices react to anything that changes what people expect those profits to be, or how much they are willing to pay for them. That means earnings compared with expectations, interest rates, news and mood. Over a single day, much of the movement is noise that nobody can predict.
The mechanics: buyers and sellers
A share price is just the last price at which a trade happened. It changes when the balance of orders changes.
If more people want to buy right now than sell at the current price, buyers have to offer more to get shares, and the price rises until enough sellers appear. If sellers are more eager, they have to accept less, and the price falls. You saw this in the order book in How the stock market works: a big market order eats through the waiting sell orders and lifts the price.
That explains how a price moves. The more useful question is why people suddenly want to buy or sell. The rest of this chapter answers that.
What a share is really worth
A share is a claim on a company's future profits. A rough but useful way to think about its price:
Price = earnings per share x the multiple investors will pay
Earnings per share (EPS) is the company's profit divided by its number of shares. The multiple is the price-to-earnings ratio (P/E): how many dollars investors pay for each dollar of yearly profit. A P/E of 20 means paying $20 for $1 of earnings.
So a price can move for two different reasons:
- Expected earnings change. The business is doing better or worse than people thought.
- The multiple changes. Investors become willing to pay more or less for the same earnings, because of interest rates, risk, or mood.
Worked example: two levers
Hypothetical Company Y. Expected EPS for next year is $2.00, and the stock trades at a P/E of 20.
| Starting price: $2.00 x 20 | $40.00 |
| Earnings outlook improves to $2.20, multiple unchanged: $2.20 x 20 | $44.00 (+10%) |
| Rates rise and the multiple falls to 17, earnings unchanged: $2.00 x 17 | $34.00 (−15%) |
| Both at once: $2.20 x 17 | $37.40 (−6.5%) |
The last line is the one that confuses people. The company's profit outlook improved by 10%, and the stock still fell, because the price investors were willing to pay for each dollar of profit fell faster.
Earnings and expectations
Public companies report results every quarter. But the market does not react to whether the results are good. It reacts to whether they are better or worse than expected.
Before each report, analysts publish estimates, and their average is called the consensus. That expectation is already built into the price. If a company earns $1.05 per share when the consensus was $1.00, that is a "beat". If it earns $0.95, a "miss".
The reaction also depends on guidance, the company's own forecast for the coming quarters. A company can beat this quarter and still fall 10% if it says next year will be weaker than hoped, because the price is mostly about the future. Earnings season covers how to read a report.
Companies must also announce major events between reports, usually within four business days, on a public filing called Form 8-K: a CEO leaving, a big acquisition, a lost contract. Those events move prices too.
"Buy the rumor, sell the news"
This old saying describes a common pattern. A stock rises for weeks ahead of an expected good event, such as a product launch or a strong earnings report. When the event finally happens and is as good as expected, the stock falls.
Why? The good news was already in the price. Traders who bought in anticipation now sell to take profits, and there is no new surprise to attract fresh buyers. It does not happen every time, but it happens often enough that you should never assume good news means a higher price.
Interest rates
Interest rates are the most powerful force on the multiple. In the US, the Federal Reserve sets a target for the federal funds rate, the rate banks charge each other for overnight loans. Its policy committee, the FOMC, holds eight scheduled meetings a year. Changes in that rate ripple out to other short-term rates, long-term rates, and the whole economy.
Rates affect stock prices in three ways:
- Competition. If a safe government bond pays 5%, investors demand more from risky stocks than when bonds pay 1%. One way to compare: a P/E of 20 means an "earnings yield" of 1/20 = 5%. That looks generous next to a 1% bond, and thin next to a 5% bond.
- Discounting. A dollar of profit ten years from now is worth less today when rates are high. Companies whose profits are mostly far in the future, often fast-growing ones, are hit hardest.
- Borrowing costs. Higher rates make debt more expensive for companies and customers, which can slow earnings growth.
This is why the whole market can move sharply on a Fed announcement or an inflation report, even with no company news at all. See The economy and stocks.
News, sentiment and flows
News comes in layers. Company news (earnings, lawsuits, product recalls) moves one stock. Industry news (a new regulation, a price war) moves a group. Economic news (jobs, inflation, growth) moves everything. Big surprises like a war or a pandemic can move every market in the world on the same day.
Sentiment is the mood of investors. When people are optimistic, they pay higher multiples for the same earnings. When they are scared, they sell good companies along with bad ones. Mood swings much more than business results do.
Flows are money moving for reasons unrelated to any one company: index funds buying a stock because it joined the S&P 500, funds selling to meet withdrawals, traders forced to sell because of margin calls, or options dealers hedging. Flows can push prices far from value for a while.
Noise: most daily moves mean nothing
On any single day, much of a stock's movement has no clear cause. Orders arrive at random, big holders buy or sell for their own reasons, and prices wiggle.
Economists have argued about this for decades. Robert Shiller's 1981 paper asked whether stock prices move too much to be justified by later changes in dividends, and found that they move far more. Prices react to changing moods and expectations, not just to the business itself.
What this means for a trader
- Short-term traders mostly trade changes in expectations and flows. Long-term investors mostly bet on earnings growth. Know which one you are doing on each trade.
- Scheduled events (earnings, Fed decisions, inflation reports) create predictable moments of big moves, but not predictable directions. Many traders reduce size or stay out.
- Because of noise, a stop placed too close will often get hit even when your idea was right. That is why Stop losses and Volatility tools size stops to how much a stock normally moves.
Try it
Open the earnings calendar and pick three companies reporting this week. Before each report, write down the consensus EPS and the stock price. The day after, record the actual EPS, whether guidance was raised or cut, and the price move. After three reports, see how often "beat" meant "up". Add the three to your Watchlist to follow what happens over the next month.
- What rough formula does the chapter give for a share price? Answer: Price = earnings per share x the multiple investors will pay (the P/E).
- Company Y has expected EPS of $2.00 and a P/E of 20, so it trades at $40. EPS rises to $2.20 but the P/E falls to 17. What is the new price? Answer: $37.40 ($2.20 x 17), a 6.5% fall, even though earnings improved by 10%.
- Consensus EPS was $1.00 and the company earned $1.05. Is that a beat or a miss, and can the stock still fall? Answer: A beat. It can still fall, for example if the company’s guidance for the coming quarters is weaker than hoped.
- What is the earnings yield of a stock with a P/E of 20? Answer: 5% (1 / 20).