Okay, okay, I still don’t understand how stock share prices are calculated. Calculating the net present value depends on all future dividend payouts? How can you do that since that’d be an infinite quantity? The idea, simply put, is by assuming that a company has zero growth or negative growth over long periods of time, the cash flow value would be constant, but the time value of money would diminish and eventually drop to almost zero, assuming steady positive inflation. Obviously, now that I state these assumptions clearly, it should be understood that this, therefore, cannot be applied generally to all imaginable economies or quantities that can be reasonably treated as economic quantities.
But, given that key assumption, the otherwise infinite series can converge to a finite number. This is explained in Investopedia’s definition of a “perpetuity.” So, now that you understand that, we can get a bit more technical on the real dynamics of the stock market. It turns out that the real listed share price is not actually calculated as such per se. The prime exception is at a company’s initial public offering (IPO), when the initial share price is calculated precisely by the formula, that of using the net present value of all future dividend payouts. After that, the stock buys and sells start having an influence on the calculated value.
Wikipedia failed to sufficiently explain, so I went web searching elsewhere to find the answer.
20200728/https://en.wikipedia.org/wiki/Net_present_value
20200728/DuckDuckGo how is the price of stock calculated
20200728/https://www.investopedia.com/ask/answers/how-companys-stock-price-and-market-cap-determined/
20200728/dividend discount model
20200728/https://www.investopedia.com/terms/d/ddm.asp
20200728/DuckDuckGo what determines the market value of stock
20200728/https://www.investopedia.com/terms/m/marketvalue.asp
20200728/DuckDuckGo how does a company calculate its share price
20200728/https://www.investopedia.com/ask/answers/061615/how-companys-share-price-determined.asp
20200728/https://www.investopedia.com/terms/p/perpetuity.asp
But how? And how does a company’s profit affect their share price?
You can try to put it like this. A company’s profit primarily affects its dividend payout, which is simply the total profit divided by the total number of shares on the stock market. The stock market then provides another stream of profit to the company, which then factors into the dividend payout, but only temporarily… unless the stocks keep getting purchased as a cash flow.
How about this piece of advice?
Corporations pay dividends as a way to share the company’s profits with the shareholders. Companies are under no obligation or regulation to calculate their dividend payout a certain way. Investors should understand the dividend policy and philosophy of the stocks they own.
And the dividend payout is generally some fraction of the total profit, though this is not required. A company could, simply by policy election, pay out more money per share than it earns in profits (for a short period of time).
20200728/https://pocketsense.com/do-companies-calculate-dividends-6337976.html
So, at the bitter end of the day, it’s all open to discretion, here.
But, wait, here is more insight.
A Company does not participate in trading of their share in the secondary market (stock market). Companies receive money from the securities market only when they first sell a security to the public in the primary market which is commonly referred to as an IPO.
20200728/DuckDuckGo stock buy sell affect share price
20200728/https://www.quora.com/How-does-a-massive-stock-sell-off-affect-a-company?share=1
So, after the IPO, the money from the stock market doesn’t actually factor into a company’s profit statement. The money, therefore, goes into a secondary pool of “purchased stocks.” That separate money pool is then what factors into a stock price, in addition to the actual (or hypothetical) dividend payouts coming from the company.
Apparently, bidding is indeed the primary means of share price assertion. But who then is the seller on the other side who determines the price? Stockbrokers.
A potential buyer bids a specific price for a stock, and a potential seller asks a specific price for the same stock. Buying or selling at the market means you will accept any ask price or bid price for the stock. When the bid and ask prices match, a sale takes place, on a first-come, first-served basis if there are multiple bidders at a given price.
20200728/https://en.wikipedia.org/wiki/Stock_market
20200728/https://en.wikipedia.org/wiki/Stockbroker
Alright, here is more insight on where the money goes after the IPO.
But the money spent to buy the stock went to the stock’s previous owner, which is usually not the company itself.
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But the important thing to understand relative to this question is the stocks are a one-time sale for the company. The company receives capital once from the initial sale, and doesn’t get any input or return when (or if!) the stocks are bought/sold afterwards.
The company does still care about the stock price, though, because of the shareholders who own those stocks (and therefore own the company). If the stock performs poorly, the shareholders will get the board to replace the company’s management team (by first replacing board members if necessary).
Ah, and here we go, mention of how “hostile takeovers” work in more detail.
The other thing that can happen if the stock prices trends too low is the company becomes vulnerable to take-over by a rival. Remember ownership of stock is ownership of the company, and a rival need only purchase 51% of the stock to control the board – often even less if there is a sympathetic investor with the ailing company. Thus a low stock price can be dangerous for a company’s very existence.
And, here finally, is the statement of the minimum model requirements for a shareholder’s decision-making, though this won’t be comprehensive enough to build a model of the whole system.
Of course, you, I, or any other average Joe are unlikely to ever reach the level where we have a meaningful reason to attend a shareholders meeting and actually vote on anything that matters to us[5]. We don’t really care about the ownership stake so much. We do care that stocks have shown stable and even increasing value over time. This makes them a useful place to park savings, that might even provide a good return.
Now, this is the kicker, on how share prices can increase. Since a listed share price already accounts for growth (ONLY at the IPO, though, your Trader Joe does this booking on discretion forever afterward):
If a company is not also growing as quickly as it can, it’s in trouble. More than that, just showing good growth is often not enough. It must also beat expectations to keep investors happy, because stock prices have often already accounted for expected growth. To raise the price further, you must exceed your own projections, which were already often optimistic in order to keep investors happy in the first place. This never-easing pressure has a profound impact on how corporations behave.
So, yeah, a good point. Want to know the share price after an IPO? This is solely, 100% determined by investor decision-making. The continuity of a share price calculation similar to the IPO calculation is solely based off of individual investors making their own such calculation in agreement, which then sets the market value of the company’s stock through the resulting buys and sells that establish the price at the agreed equilibrium.
20200728/DuckDuckGo do companies receive money from the stock market
20200728/https://money.stackexchange.com/questions/94507/how-can-a-company-use-money-from-stock-investors-when-they-are-constantly-being
One last area of research, what is the role of stock exchanges in the stock market? They are the “assocation” that stockbrokers form together when there are events that one cannot wholly handle on their own, like list price agreement, financial debts/surpluses based off of list price changes, and so on.
20200728/https://en.wikipedia.org/wiki/Stock_exchange
So, there you have it. Now I can summarize the few, the only hard ground rules of the stock market.
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A company’s bank account only earns money from the number of shares created at its Initial Public Offering (IPO) and the corresponding initial list price of those shares. The calculation of that list price is based off of a net present value computation of all future dividend payments, possibly accounting for projected growth, and definitely assuming positive inflation so that the infinite series computation can be convergent on a finite number. Specifically, the fact that each future dividend payment will be the same dollar value, so therefore its value adjusting for inflation will be less in equivalent dollar value at the present.
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After the IPO sale, the company’s bank account gets nothing out of the stock deals. Anything related to the stock market that affects the company is wholly indirect through secondary vehicles that base their decisions off of the stock market. Therefore, the primary benefit of the stock market is to shareholders, and this is two-fold.
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Shareholders are granted a fractional payout of a company’s profits, paid out in dividends proportional to the share of stocks someone owns in a company. However, the exact terms of this are totally negotiable in the stock agreement, and some companies may agree to not have a dividend payout at all.
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Shareholders are granted fractional control over the company’s board of directors decision-making. Again, the exact terms of this are totally negotiable in the stock agreement.
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How then can further stock sales happen after the IPO? This is wholly based off of putting money into other investor’s pockets. Or, in the case of a company’s shares on the stock market decreasing, taking money out of other investor’s pockets. From a money flow to bank accounts standpoint, the money principally flows from a individual investor’s bank accounts to a bank account owned by the stockbroker, then it can be dealt out from there back to individual investor’s bank accounts. (Stockbrokers themselves band together as an association to make the stock exchange, so from there they can make agreements based off of where money needs to flow based off of how stock prices change.) The company’s bank account is totally detached from all financial transactions that happen here.
So, how is the share’s list price determined in this market? It’s totally based off of crowd dynamics. The stockbroker’s collectively has a pool of money associated with a stock, and then they, through the stock exchange, arbitrate the asking price based off of “supply and demand” dynamics, though there isn’t a finite supply of shares. When more people buy the stock, they arbitrate a price increase. When more people sell the stock, they arbitrate a price decrease.
The problem here, is that this can leave a pool of money still “left on the table” after all shares have been sold. Where does that money go?
Incidentally, it can be used to help solve problems related to running a stock brokerage firm. Suppose a company has an IPO, every IPO stock is bought, but then every single last stock is sold. The problem here is that all money from purchases was sent directly to the company, so where does the money come from to fulfill sells? Ultimately, it must come from a profit made elsewhere by the stockbroker.
But, in the midst of all this crowd valuation, the fact that some sanity settles on prices is because of this dynamic. There are people who are calculating what they believe should be the effective value of stocks, based off of a similar calculation used at IPO, and will buy and sell if there is a price difference. The stock exchange will increase and decrease the price accordingly, until it finally settles at an equilibrium that reflects the average of these these calculated assertions of the stock’s value.
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The most immediate secondary way in which the money in a stock can get into a company is through stock options given as a benefit to employees, especially executive-level employees. Through this linkage, an executive can sell their shares in a company, then move the earned funds from their personal bank account into the company’s bank account.
As an exceptional event of this, there can be an agreement for a “stock buyback.” The company will delist a stock from the stock exchange, and stock holders will get an agreed portion of the total money value on the stock market. The rest will go to the company itself, and then no one will be left who can own stock.