I have always been puzzled by the sudden changes in stock prices. I have always been puzzled about gap ups and gap downs. The question to brood over is, suppose the price of some odd scrip A is 100 today and stock market is closed for 10 days; when the market opens after 10 days, what will be the price of scrip A? Will it start from same level?
Law of supply and demand somehow doesn't appeal to me in such case. For I strongly believe that in stock market, supply is always equal to the demand. There is no 'stock' inventory lying in the NSE/BSE warehouses.
We can take a cue from PE ratio and propose a plausible explanation. Certainly there are many much complexity is involved, but for the simplicity sake we can start with the PE ratio. What is the meaning of PE ratio 10. Well it means that if a companies earnings remain same and it pays all its earnings as dividends, it will take us 10 years to break even. This also means that the money invested will work like an FD with simple interest of 10%.
Now this is what may happen:
Law of supply and demand somehow doesn't appeal to me in such case. For I strongly believe that in stock market, supply is always equal to the demand. There is no 'stock' inventory lying in the NSE/BSE warehouses.
We can take a cue from PE ratio and propose a plausible explanation. Certainly there are many much complexity is involved, but for the simplicity sake we can start with the PE ratio. What is the meaning of PE ratio 10. Well it means that if a companies earnings remain same and it pays all its earnings as dividends, it will take us 10 years to break even. This also means that the money invested will work like an FD with simple interest of 10%.
Now this is what may happen:
- Some people think that they can manage with 8% of simple interest and start bidding high for a Rs 100 stock. To get Rs 100 in 10 years with 8% simple interest they would have to pay 125 for Rs 100 stock. This change happen smoothly and we see gradually PE ratio. In this case it will be 12.5. But earnings of a company are hardly constant. A business will always try to run a direction where it can increase its earnings. If we assume that earnings may increase with the constant rate of 10%, we will get return of Rs 100 within 7 years. This too will take the prices higher due to those who would be satisfied with returns in 8 years or 9 years or more. If suddenly there is some revelation the companies earnings are going to drop, people think that their 8 years may now extend to 12 or more years. They start selling; Since they cannot sell a costly asset for the same price, they will reduce price and those who are willing to go ahead with that kind of risk will be happy to buy.
Taking all those factors in to account, the valuations made by people decides the price of a stock.
Ever wondered why M&M is shooting up? People are happy due to its venture into electric car and think that the earnings will shoot up some day as green technology is the future.
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