The Relationship between Oil Price and The Stock Market (2)

Oil governs many parts of our world and for businesses – companies you and I invest in; hence, there are tons of ways their operations can be affected by oil.

The reason the rise and fall of oil is important enough to get the whole world talking is because of its impact in our world as well as the dependency we have on it in various facets of our lives.

Oil governs many parts of our world and for businesses – companies you and I invest in; hence, there are tons of ways their operations can be affected by oil.

In our last post, we analysed the importance of oil on our society and the varying perspectives on whether it has anything to do with the stock market or not.

However, whether oil prices are enough to disrupt stock markets or not, there are direct and indirect influences it has on companies. The following are some of the ways it impacts companies over time.

Impact on Profit

A number of things like interest rates, inflation, and taxation could impact the profitability or otherwise of companies, and movements in oil price is one of them. In a company’s books, oil expenses (usually for power – fuel & diesel) could be so high, it creates a dent in the earnings of the company or vice versa.

It could also affect transportation costs as well. Depending on the kind of company, these cost differences could be marginal (say for service-based businesses) or a lot (say for aviation companies).

An understanding of this will offer insights into what you hedge your funds against or the kind of industries to invest in based on the trends in oil.

Impact On Disposable Income

When you spend too much on power costs or transportation costs, it is only natural that you have less money to spend on other things. This has an indirect implication on businesses that are non-essentials as less people can afford to spend on them.

What this means is that oil prices could cause business’ customers to spend less.

Impact on Inflation

Another impact of changing oil prices lies in how it affects inflation. A good example is transportation. When the price of fuelling is higher, motorists are forced to increase their costs, sellers who transport their goods also increase the price they sell these goods because of the increased cost of transportation and this transcends through the entire economy.

It then becomes expensive for people to carry out business as usual. Of course, the companies we invest in are also affected as expenses are even higher.

The Need For Diversification

In situations where the rest of the nation stays panicking about rising oil prices, there are certain winners. Not all companies are negatively impacted by rising oil prices.

For oil companies, the costs spent in extracting the oil does not increase or decrease as a result of the changing market prices. So in periods where other companies are grappling to save their earnings, the oil industry will earn higher profits.

It is for this reason that you should diversify your portfolio. By diversifying, you get to hedge inversely proportional companies and this will keep your investments stable.

Written by Lawretta Egba.