What makes an individual stock worth it's price?

Question

I understand the law of supply and demand, so that when more people want to buy, the price goes up and vice versa. But what makes people want to buy???

For example, I think Company A has a good idea for a product. Why do I buy their stock? Just in hopes other people will want it in the future and be willing to pay more for it?

Do dividends make a company more enticing to buy? Do all companies give dividends?

Is there a ratio between the stocks a company has and its earnings? Is this the P/E ratio? How do I interpret the P/E ratio? what are its units?

Something is still missing...

Serge mentioned 'discounted cash flows' which i will look into.

Is it just about owning sexy stocks? So i can say, "I own 1000 shares of XXX" to my friends?

Is there a direct link between profits, and share price. Is there one?

Additional scenario:

Company A is consistently profitable, offers consistent dividends.

Company B has high expected profits, and is looking for growth.

Is my only criteria for investment what I think the demand for stock will be in the future? Am I just betting on what other people will want in the future?
This is confusing...

Oh wait!
Will companies eventually buy back the stock issue???? Are you betting on the price the company will be willing to pay to buy back the stock???

Hmmm...

Answer 1

You are correct about the supply and demand issue. Investors will demand the shares of a company when they evaluate the company and decide what they think it will accomplish in the future. Theoretically, the current price of the stock is the discounted value of its future cash flows. However, no one knows what the future will bring. Investors look at what the company owns, what it is earning by employing its resources, what the prospects are for the earnings to grow, the company's position in its industry, and many other factors that determine how much they ar willing to pay for a share.

All companies do not pay dividends. Whether dividends make a stock more enticing really depends on the investor. Investors who are interested in dividend income will look for stocks that have a good history of stable dividend payments. Investors who prefer capital gains will look for companies that are plowing their earnings back into operations in order to grow, take advantage of new technology, and develop new products.

The Price/Earnings ratio is a measure of how expensive a stock is. A $10 stock that is earning $1 per share has a P/E ratio of 10. Another $10 stock earning $0.50 per share has a P/E ratio of 20. The second stock is more expensive, i.e. you have to pay twice as much for a dollar of earnings. Why is the P/E ratio of the second stock so much higher? Probably because investors perceive the first stock will continue earning $1 per share, but they think the second stock may earn $1 per share next year, $1.60 per share the year after, and $2.40 per share the year after that. They are willing to pay more for the prospect of rapidly growing earnings.

Answer 2

A share of stock is part ownership of a business. So if it is a good business you would want to buy it. A good business makes a profit and grows. Some companies are into growing like crazy opening new stores daily like Starbucks opening hundreds a year, they need the money they have to open more so don't give dividends probably. Some companies like McDonalds are established and earning profits every year. When they do new things and same store is selling more every year it is better to own it. If they do something stupid like selling spinach nobody will eat there, profits are down and you don't want to own it. When they make a profit they send you $1 per share or about 2% per year. Stocks that pay dividends are nice if you want to get some money rather than have a company that reinvest the profits into growth.
P/E is a price earnings ratio Divide the Price of a share by how much a share earns so if you company earns $2 for each share and a share cost $50 you would be earning a P/E of 50/2=25. A public utility might earn a smaller P/E because people want growth. you might find price = 25 profit =2 for a P/E or 12.5 but they give you 6% back as a dividend so if you are living on income and don't want as much risk you might choose that stock. Young risk takers wouldn't like it since you are taxed on dividends and you want your money to grow not be given back.

Answer 3

People buy for all sorts of reasons - The Biggest is They think they will make money on it!

People buy on rumours tips, insider knowledge, technical analysis - cause their relative bought it.

What drives prices is what Keynes called "Animal Spirits" and herd mentality.

Some investors buy for growth in price or capital gains so dividends do not matter.

Some investors buy for security of cash flow so dividends do matter.

Companies usually need a stable & positive cash flow and profits to pay dividends so not all companies pay dividends.

Price Earnings Ratio is simply a ratio of the Current Share Price to the Last Reported Earnings Per Share (EPS).

Interpretation of P/E is more art than science!

Why - because one part is a known current piece of information and EPS is a Past peice of data that will be different right now.

Generally a rule of thumb is that High P/E ratios indicate stocks with greater EXPECTED growth potential in EPS in the future.

Low P/E stocks are often steady as you go boring stocks that may pay nice dividends. BUT you must look beyond that ratio to what is happening with the business itself - what is changing and likely to change.

Answer 4

A stock's value is based on the estimated cash flows in the future that the company can afford to pay out to shareholders. Dividends are part of those cash flows. So in a way it makes no difference if a stock pays a dividend.

Answer 5

Dividends what give stock value. Not all stocks pay dividends. However, they are expected to at some point in the future. P/E ratio is the Market price of a stock / Earnings per share. Earnings per share is [(Net Income - Prefered Dividends) / Number of Shares out standing] which lets us now the value earned per share. So anyways P/E ratio is just a ratio of the price of the stock compared to its earnings. This has little value unless compared to similar stocks.

Answer 6

Yes. It's all true.

Some people buy for the right to collect the dividends.
Some buy thinking that they can sell later for more.
Some buy because they think that discounted cash flow is a magic formula (the people that sell to them think that discounted cash flow is dumb).
And some are like my relative, who actually did buy something so that he could say that he owned it at parties and not feel left out.