By Ann Coleman (TMF AnnC)
May 11, 2000

It's my impression that the public in general, and even many experienced investors, view stock prices as something of a mystery. They know it's good when their stock's price goes up and bad when it goes down, but why a stock is fairly priced at $55, but overpriced at $75, is as mysterious as television to a two-year-old.

Worse than mysterious, though is the feeling that the prices are simply not rational. It's one thing not to know how those little people got into the TV, but it's quite another to suspect that they got there by magic.

If you've been hanging around the Fool for long, you've probably noticed that it is our mission to teach people that there is nothing magic about stock pricing. If you want to pick your own stocks, you can't do that successfully if you don't know when you are paying too much for a stock and when you are getting a bargain.

On Tuesday Barbara Bayer discussed why stock prices fluctuate on a day-to-day basis. It's a simple matter of supply and demand. But what influences demand? What causes someone to want to buy or, for that matter, sell a stock? That's what we will be exploring today and tomorrow.

There are a million reasons why someone buys a stock and creates demand, but when you look closely, most of them come down to one thing -- the price. You buy a stock only because the price is such that you expect to be able to sell it for more at a later time. This is pretty obvious. Day traders may expect to sell it for a $0.25 per share profit in 15 minutes, and Rule Maker investors may expect to be able to sell it for a 3000% profit when they're 64, but no one buys a stock expecting to sell it for less. (Even short sellers expect to sell at a higher price than they paid -- they just sell first then buy it later.)

All of the discussion about overpriced technology stocks and skyrocketing IPOs hinge on this idea. On the one side are the technophiles who focus on the potential earning power of world-changing technologies like the Internet. To them, the real problem isn't paying too much, but failing to see just how much potential is in these technologies. What would General Motors <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %> have been worth in 1900?

On the other side are the empiricists who want to see just how a company like Yahoo! <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YHOO)") else Response.Write("(Nasdaq: YHOO)") end if %> plans to create real shareholder value that will justify the stock's price. They are the folks who quote Price/Earnings ratios and point out just how absurd a P/E of 544 (Yahoo's P/E today) is when historically most companies have sold for P/Es that average around 15.

I tend to be a technophile, but I'm really, really happy to have a few rock solid companies in my portfolio that can churn out cash in the here and now. Here are the P/E ratios for our Foolish Four stocks:

General Motors <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %>   9
JP Morgan  <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %>     12
Kodak <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EK)") else Response.Write("(NYSE: EK)") end if %>           12
Caterpillar  <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %>   14