Stocks
Young Fools
March 25, 1998

Stock Prices and Value

What Stock Prices Mean

Let's imagine a company called Squid City. It's a chain of stores across America that only sell squid-related things. They sell fried squid, frozen squid, squid ice cream, squid-shaped furniture, squid perfume, big stuffed squids for children, and even pet squids. Squid City trades on the New York Stock Exchange, and its ticker symbol is SQD. There are 20 million shares of SQD, and each is trading around $30 right now. This means that Wall Street is valuing Squid City, the company, at $600 million. (20 million shares times $30 each equals $600 million: 20 x 30 = 600.) This $600 million is called its "market capitalization."

Things can change quickly, though. If SQD falls on hard times, its price might fall by half, or 50%, to $15 per share. Since 20 million shares of SQD still exist, that means the company is now valued at half of what it was before -- $300 million. (20 million shares times $15 = $300 million.) If someone comes along who wants to buy the whole company, he can buy it at a bargain price. Maybe Bill Gates is thinking of incorporating squid into Microsoft software? Probably not. But Wal-Mart or Kmart might be looking to expand their offerings to include more squid products.

Squid City might really be worth more or less, when you take into account its factories, stores, equipment, cash, future sales, and other things. But in many ways, "the market" (which means Wall Street or investors in general) values a company through its stock price.

Price and Value

The key word in the last paragraph was "value." A stock price is all about value -- about what kind of price investors put on a company. If everyone thinks that Squid City is going to be an amazing success, and will grow very quickly, then lots of folks will be buying shares in the company. But there are only so many shares available. Only those 20 million. And many of them are being held by people who don't want to sell, at least not at the current price, because they expect big things from Squid City.

Imagine a store that is selling t-shirts which feature scenes from the enormously popular movie Titanic. For a while, as long as there isn't a lot of competition, it can charge a high price because everyone wants them and people will pay a high price to get them. After people get tired of Titanic, though, and move on to the next big movie (perhaps Armageddon), the price of the t-shirts will drop because people will not be so eager to buy them. In economics, these are the laws of supply and demand. If demand is high and supply is low, prices will rise. And vice versa.

It's the same thing with stocks. When more people want to buy the stock than sell it, the price gets bid up, kind of like at an auction. When more people want to sell their shares and buy something else, the price goes down. But what makes people want to buy or sell the shares? There are a lot of reasons. Some of them make sense, and some are silly. But they all can have an effect on stock prices.

Check out a lot of reasons why stock prices move.

Stocks

What is Stock?
The Case for Stocks
Stock Prices and Value
How Do Stocks Move?
Dividends
What are Mutual Funds?
What are Index Funds?
Stock Splits