How is a companys share price calculated

The more demand for a stock, the higher it drives the price and vice versa. The more supply of a stock, the lower it drives the price and vice versa. So while in theory, a stock's initial public offering IPO is at a price equal to the value of its expected future dividend payments, the stock's price fluctuates based on supply and demand. Many market forces contribute to supply and demand, and thus to a company's stock price. Understanding the law of supply and demand is easy; understanding demand can be hard.

The price movement of a stock indicates what investors feel a company is worth—but how do they determine what it's worth? One factor, certainly, is its current earnings: how much profit it makes. But investors often look beyond the numbers. That is to say, the price of a stock doesn't only reflect a company's current value—it also reflects the prospects for a company, the growth that investors expect of it in the future.

There are quantitative techniques and formulas used to predict the price of a company's shares. Called dividend discount models DDMs , they are based on the concept that a stock's current price equals the sum total of all its future dividend payments when discounted back to their present value. By determining a company's share by the sum total of its expected future dividends, dividend discount models use the theory of the time value of money TVM.

Several different types of dividend discount models exist. One of the most popular, due to its straightforwardness, is the Gordon growth model. Developed in the s by U. Or, as an equation:. Continuing with our Walmart example, analysts forecast average annual EPS growth over the next five years of 6. A stock with a PEG ratio below 1.

Several metrics can be used to estimate the value of a stock or a company, with some metrics more appropriate than others for certain types of companies. Companies in industries with low profit margins typically need to generate high volumes of sales. Another useful metric for valuing a stock or company is the price-to-book ratio. Price is the company's stock price and book refers to the company's book value per share.

A company's book value is equal to its assets minus its liabilities asset and liability numbers are found on companies' balance sheets. A company's book value per share is simply equal to the company's book value divided by the number of outstanding shares. A company's price-to-book ratio is only marginally useful for evaluating companies, like software tech companies, that have asset-light business models.

This metric is more relevant for evaluating asset-heavy businesses, such as banks and other financial institutions. A stock can appear cheap but, because of deteriorating business conditions, actually is not. These types of stocks are known as value traps. A value trap may take the form of the stock of a pharmaceutical company with a valuable patent that soon expires, a cyclical stock at the peak of the cycle, or the stock of a tech company whose once-innovative offering is being commoditized.

A company with a defensible economic moat is better able to compete with new market participants, while companies with large user bases benefit from network effects.

A company with a relative cost advantage is likely to be more profitable, and companies in industries with high switching costs can more easily retain customers. A value calculation cannot be based solely on numbers from financial statements. James Woodruff has been a management consultant to more than 1, small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues.

James has been writing business and finance related topics for work. By Jim Woodruff Updated February 01, Financial Industry National Authority: Stocks. Another way to figure the price-to-sales ratio: Find the market value share price multiplied by outstanding shares and divide it by the total amount of sales for the previous fiscal year. Stock prices change everyday by market forces. By this we mean that share prices change because of supply and demand.

If more people want to buy a stock demand than sell it supply , then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall.

Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies.

That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth.