Let’s discuss how market forces determine a company’s stock price.

The News

Ever noticed a stock price jump or dip after a company announces a new product or venture?

Take Mahindra, for instance. They recently unveiled a new SUV with a refreshed brand logo aimed at EV enthusiasts. As I write this, their stock is up by 1%.

In other news, yesterday Ola Electric also launched new scooters catering to gig delivery workers. Following the news, the stock went up by 20%.

So, what drives these price movements?

Market’s Perception of Events

Market perception revolves around how investors at large interpret the information and its potential impact on the company’s future.

When a company announces a new venture, its future success remains uncertain. If the market believes this venture could negatively affect the company, investors would sell their shares, pulling the stock price down.

A good real-life example of it is Zomato. On 24th June 2022, it announced the acquisition of Blinkit. Following the announcement, Zomato’s stock price fell over 20% in ‌just one week.

The reason?

The market at large perceived that it would have a negative impact on the company’s future. But today, if you see, Blinkit contributes over one-fifth of Zomato’s revenue and growing faster than its food delivery business.

The point I’m trying to make is that most of the short-term market movements (either side) are not fundamental, but based on perceptions and sentiments.

But hey, what forms a perception?

How does perception form?

Institutional Investors such as banks, mutual funds, and insurance companies often make decisions based on a top-down approach.

Intuitively, all investors, more or less, do the same thing. If you are investing in a particular company, you often start by looking at the bigger picture—global economic trends, industry performance, and sector growth.

Once the broader picture is clear, the focus shifts to the company itself. Is it financially strong? Does it have a clear growth strategy? Where does it stand overall in the bigger picture?

Say, for example, you’re considering investing in a company like Tata Motors.

You’d first look at the broader landscape: how is the global auto industry performing? Are electric vehicles gaining traction in India? What government policies are supporting EV adoption?

Once you’re confident about the sector’s growth potential, you’ll dive deeper into Tata Motors. Is it financially healthy? Does it have a solid EV strategy? How does it compare to competitors like Mahindra or Maruti?

Going further, you would keep updating your stance based on developments, such as quarterly earnings reports, changes in key management, acquisitions, and other key decisions affecting the company.

This layered thinking is what drives the decision to buy or sell the stock.

Now, unfortunately (or fortunately) there is not just one way to look at things. Something that seems a positive development to one investor might appear negative to another.

Now, you might have guessed why equity markets are volatile. It is a psychological play at large.

To Conclude

In the short term, investors’ perceptions and sentiments often dominate, leading to volatility in stock prices.

However, these distinct perceptions serve an essential function—they ensure that, over the long term, stock prices and the market at large realign with their fundamentals.