Why do stocks in these markets go up or down?

Answer 1

It's ALL about earnings -- how much money the company makes (or doesn't make) -- good old fashioned profits -- the bottom line. This is a true answer that is very easy to lose sight of when internet stocks are selling for hundreds of times the earnings that they don't even have, yet, and in-the-red IPOs that end in ".com" rise to higher market capitalizations during their first day of trading than companies that actually make lots of money and have been doing so for years.

You see, another answer, but one that is "less true," is that stocks go up because of hype. Hype, momentum, the greater fool theory -- all ways to describe the seemingly irrational way some stocks behave. But when you look closely, you will see that the hype is always about earnings.

I said this answer was "less true" because although stocks do go up because of hype and momentum, they also go back down eventually unless the earnings are there to sustain them. When hype-based momentum turns around, it can get ugly.

One of the few indisputable facts of investing is that over the long term, stock prices rise because company earnings rise, or vice versa. But the fact that stocks rise because of earnings is only long-term truth. Prices don't track earnings that closely over short time periods, and even long-term, the relationship is not necessarily precise. There's a lot of room for hype.

At any given point in time, stock prices within some earnings-dictated range are more influenced by the market's perception of what earnings will be. Not what earnings are, but what they will be. Sometimes those perceptions are realistic, sometimes they are wildly unrealistic. But always the perceptions are about earnings.

One of Wall Street's truisms is that if you know the price of a stock will go to $50 tomorrow, it will go to $50 today. Think about it. If you know a stock is going up, the natural reaction is to buy it. If "everyone" knows it 's going up, and, therefore, "everyone" starts buying, what happens? Increased demand plus limited supply equals increased price. As the price approaches what "everyone" thinks it will be tomorrow, demand slows to equal supply, and the price levels off.