Fundamental Factors that Affect Stock Prices

While technical factors explain why short term price changes occur, fundamental factors will help you understand long term price changes and they ultimately matter more

In our last few posts, we took another look at the very things that are responsible for the volatility of prices in the stock market. While we reviewed the technical factors which are essentially external conditions that affect the supply of and demand for a company's stock.

Fundamental factors, as we will discuss here, represent those that are based on the companies themselves. They represent the factors that drive stock prices as a result of company earnings and profitability from carrying out their normal business activities.

Key fundamental factors that determine price movements in the stock market are broadly classified into those that are as a result of its earnings and those that are as a result of its valuation.

These are key methods of analysis that guide analytical decision making and an understanding of them will help you determine what ratios to look out for. Here’s how they work:

Earnings Of The Company

An easy way to understand this is that as an investor, you have a stake in the companies you invest in. You have a share and are essentially an owner. When the company is doing well fundamentally, you can tell by its revenue earnings as well as its profitability.

However, a determinant of whether that venture is successful or not is tied to its potential to make more money – its future earnings. It is important to note here that high profits do not necessarily mean that there’s going to be high stock price and huge losses also do not mean that stock prices will take a dip.

Rather, the core fundamental factor that determines stock prices are the current earnings together with the promise of future earnings. If the future seems bleak for your investment, best believe that the price will start reflecting that drop in earning capability through its stock price no matter how good the sentiments are of it in the stock market.

The Valuation Multiple

Without going too far into financial analysis, valuation multiples are tools that are used by analysts to make financial forecasts or show the expectation for the future of a company/ stock.

Just the same way you compute compound interest based on a certain discount rate as well as the current principal sum, the valuation multiple employs a discount rate to determine the expected growth in earnings.

A higher growth rate will make the stock have a higher multiple and vice versa. However, a higher discount rate will reveal a lower multiple (this is because discount rate accounts for things that reduce the value of your investment like inflation, risk etc.).

The valuation process helps in determining the current and projected worth of an asset or a company taking in all factors. Since you are purchasing a proportional share of the company’s future earnings, the multiple serves as the price you are willing to pay for the future earnings.

Multiples are pointers to price movements in the stock market. Multiples are also compared across industries and ultimately guide market or investor perception about a stock, all of which affect volatility.

It is pertinent to note that while technical factors explain why short term price changes occur, fundamental factors will help you understand long term price changes and they ultimately matter more.

All things being equal, a company with strong fundamentals will do well regardless of the many technical factors that are thrown at it. To review the fundamentals of your favorite stocks, simply click on any company on the Yochaa heat map and asses the already computed stocks.

Written by Lawretta Egba