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Before even starting or saying anything, let us say it loud that stock price does not reflect the true value of a company. If the stock price was supposed to show the true value of the company markets would have been very dull and boring for everyone. There wouldn’t have been any thrill in the markets if the stock price was everything for making an investment decision.
The stock price is just an amalgamation of perceptions of investors which is governed by greed or fear. The uncertainty of the markets coupled with unpredictable investor behaviour moves the stock price upwards and downwards. This behaviour of investors causes a disparity between the true worth of a company and the stock price trading in the markets.
But is it that stock price doesn’t matter at all?
We didn’t say that. Stock prices do matter and maybe it matters even more in today’s context. A good stock price is able to attract investors (like in the case of Reliance) as it signifies good times are ahead. Everyone becomes crazy to get a piece of it. This action further drives the stock prices upwards. Such stocks become media favourites and talk of the town.
One such story was Ruchi Soya, where it beats Marico in market cap. Click here
Truth be told, increasing stock prices do benefit a company. As it benefits companies to undertake expansion plans without worrying about resources. A herd of investors are ready to invest in the company and get a share of it. It helps the company to get a favourable merger deal due to the bargain in share swap deals.
An increasing stock price also keeps creditors and bankers happy. Bankers are willing to lend money at favourable interest rates and be assured that the company will be able to pay the loan. Also, get a high credit rating which helps the company to pursue long term investment plans at lower interest rates.
Stock prices also help to retain and recruit excellent talent. Employees tend to feel motivated when they get ESOPs and the stock price is good and fancied in the market.
A positive stock price tells that the future of the company is optimistic.
On the other hand, depressed stock price reflects pessimism in the markets and gloomy future of the company. It becomes very difficult to attract the best talents if stock prices are falling or not performing well. In this kind of a situation, stock options don’t serve any motivation to employees.
Moreover, investors are not willing to invest as it doesn’t show an optimistic future. Banker and creditors don’t feel safe to lend to these companies and thus charge a higher rate of interest. It becomes very difficult for such companies to raise money through the right issues or IPOs.
Thus, it becomes very important for the management to ensure that the stock prices reflect true and underlying business value.
What does stock price mean to retail investors?
If you want a straight answer, the stock price shouldn’t mean much to you. As a retail investor, you should consider stock price just like an anemometer. It just shows the direction and perception of millions of investors. Not the value.
Value of a company is determined by various factors like the company’s ability to generate free cash flow, the debt of the company, return on capital employed, management integrity, future earning potential, the relevance of the business in today’s world and lot more.
Ideally, a DCF is used to value a company. If you haven’t heard about a DCF. Click here
A retail investor at no times should try and time the market based on the market price. Doing this will only burn your fingers.
For retail investors to do well in the markets, they should stick with great companies with strong sustainable competitive moats run by great management. There might be temporary troubles in the journey but trust the people who are running the business and keep a long term perspective.
“Waiting helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”- Charlie Munger
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