Isn't it strange how this whole world revolves around the law of supply and demand? For those of you who are not economics majors, here is a quick lesson. If an item or service is in short supply, people will pay more for it, if the demand out-strips the supply. On the other hand, if there is an abundance of a good (supply) and there is little demand, the price will fall.
For example, do you ever wonder why you pay a lot for the new Sega game console when it first comes out? It's because there aren't many out there and everyone is trying to get one. Whether you are purchasing an item at a Super Wal-Mart, filling up your car with gas or trying to get a date at a local nightclub, the law of supply and demand comes into play. Look around and you will figure it out.
The IPO market is a great example supply and demand in action. Often, the first day a stock hits the market, there is greater demand than there is supply of stock. When this happens the stock will run up on the first day of trading because there are more investors looking to buy the stock than sell it. Many variables affect the way a stock performs in today's market, including company announcements, interest rates and economic conditions. Here are a few things to pay attention to.
The announcement of company news can make or break a stock. When a company reveals a new product, technology or perhaps a new line of business they will venture into, Wall Street and investors have a reaction to it, which may be good or bad. Sometimes it takes a while for investors to step back and investigate how this may affect the bottom line. For example, when AT&T decided to go into the cable and high-speed Internet market, Wall Street didn't seem to like the move. Although they have a great brand name, they didn't have the first mover advantage to this industry. They have been a quality company in past years, with good earnings and a low price to earnings ratio, but many analysts feel AT&T may not be profitable in this segment, which has dragged the stock price down severely.
Mergers and Acquisitions
Everyday we turn on the TV or log onto the Internet, we hear about one company buying another or deciding to merge. One method that companies move into new markets or maintain dominance in a market is through acquisitions. The biggest merger ever between America Online and Time Warner should finally take place later in the year forming the biggest media company in the world. The day when America Online announced they would buy Time Warner for $183 billion in stock, Time Warner's stock rocketed up 40 points intra-day. News of big mergers like the AOL/ Time Warner deal, usually send the company that is being acquired much higher. In the long term, the stock of the company being acquired eventually converts to the company making the acquisition, only if it is a stock for stock deal. Many mergers and acquisitions are cash deals.
Another factor that affects a stock price is the restructuring of an organization. Would you buy the stock of a company who is constantly downsizing? The strategic goal for a company is to grow and gain market share. They do that by consistently increasing earnings and revenues, which in turn, comes from the quality of the labor. Investors might respond to a stock when there is a major shakeup in the organization. For example, when the CEO steps down, some might see this as being negative, but others might accept the restructure as a much-needed change going forward. The officers are the insiders who are involved in the strategic development of the company. Without quality management, no company can succeed over the long term.
Analysts Upgrades and Downgrades
Everyday, senior analysts from various firms will upgrade or downgrade various securities. Some of the more well-known analysts such as Ralph Alcompora from Paine Webber and Mary Meeker from Morgan Stanley Dean Witter appear on CNBC from time to time and have the power to make or break a stock. One example of an analyst really is when Thomas Bock, an analyst at SG Cowen gave QXL.com (QXLC) a strong buy rating and a 12-month price target of $1000. QXL.com is a European online auction very similar to EBAY. The day Thomas Bock made his upgrade and said QXL has the first mover advantage in Europe and a very attractive business model, the stock soared in the morning to as high as $117. Investors then stepped back and questioned what this guy really said. The stock is currently trading under $10. This is a perfect example of how an analyst gives their personal opinion and drives up the price of a security only to have it later fall back to earth. It was found out later that SG Cowen underwrote the QXL.com public offering. Any coincidence you think?
Simply put, all of these factors may make a stock fluctuate in price over the very near-term, but the real reason a stock goes up and down in price is the number of buyers and sellers, again relating back to the law of supply and demand. If a stock is in high demand and there is limited supply, investors must pay more for it. That point in between where buyers and sellers come together is called equilibrium. Take a step back and think how much the law of supply and demand affects our lives everyday.