How are share prices calculated?

If you’re new to investing, share prices may be a mystery. They seem to go up and down, and barely stop for breath in their fluctuating journey. But what are the factors that go into calculating that seemingly ever-changing number?

Like many things sold in markets, supply and demand drive share prices. This means prices can rise when more investors are buying a company’s shares and, on the flip side, fall when more investors sell the company’s shares. Yep, investors are part of determining a company’s share price.

Share prices - never same same, but (always) different

Share prices are the original fidget spinners, they do not sit still. Why exactly do stock prices change every second? As long as shares are being bought and sold, the prices fluctuate. Typically, share prices move up and down steadily, but they can occasionally swing sharp and fast, like during a market drop or rally. If you’re investing, this movement can sometimes feel like a bit of a never-ending roller coaster, and not the fun kind! 

That roller coaster that spins out a tonne of emotions can also be called market sentiment. Aka, how investors are feeling (especially during times of uncertainty, 2020 global pandemic crash anyone?). In fact, market sentiment is one of the three fundamental factors that can move share prices.

Things that affect supply and demand

It isn’t just investors who can impact share prices. The supply and demand for a company’s shares can be influenced by how the company is performing day-to-day. If Company A is beating earnings forecasts, and their future growth prospects appear to be on target, demand for their shares can rise as more investors are vying to own shares in what looks like a ‘successful’ business. Conversely, if Company A doesn’t appear to be doing so well and investors sell their shares, demand can fall, leading to a dip in the share price.

So, if the quality of a company determines the investor demand and supply in the market, it’s another indicator that it’s important to do your research when it comes to investing. Think of a brand that you use every day - one that you’d be interested in learning a bit more about. How does it make money? What are the company’s mission and growth plans? Are they growing? How strong are their competitors, if any? This is where searching online is useful, where you can read up if other investors and analysts consider their share a ‘buy’. 

Supply factors that affect share prices

Supply is the amount of something available, and supply factors that can affect share prices include:

• The number of company shares issued
• There are always a limited number of shares up for grabs for any given company. But if lots of investors want to buy a share and the supply is low, the share price typically goes up.
• Share buyback
• This is when a company buys back their own shares from investors to reduce supply, and reducing the total number of shares in circulation to increase the share price.
• Sellers
• When investors sell their shares, this increases the supply available in the market. If demand doesn’t match this increased supply, the price of shares goes down. 

Demand factors that affect share prices

Demand creates share value. If no one wants a company’s shares, they’ve got no value. Demand factors that affect share prices include: 

• Unexpected company news
• When a company hits the headlines, share prices can move. Anything from earnings reports, product launches, or even a simple tweet from an influential investor can lead to swings in demand and share prices. The global pandemic that’s been disrupting lives since 2020 has also caused many businesses disruption leading to less demand for their shares.
• Economic happenings
• Changes in interest rates, how economies are tracking and inflation can all influence share prices. For example, if interest rates and inflation go up and the economic outlook is dire, demand usually goes down, and share prices can follow suit.
• Market sentiment
• Market sentiment is the overall feeling investors have about specific company shares or even an entire industry leading to a loss of confidence (or increase!) and changes in share prices.

Initial Public Offerings set share prices too

It’s helpful for investors to know how share prices are determined for an IPO (initial public offering). This is when a company ‘goes public’ and sells their shares for the first time on the share markets. During this process, the share price is set according to the expected supply and demand for that company’s stock. 

Of course, when the newly issued shares hit the share market, they don’t sit at that initial price for long (remember our fidget spinners?!). After an IPO, a whole range of factors can influence the share price. One example is that if early investors in the company sell their shares after the lockup period ends, this increase in supply could flood the market and bring the share price down.

You can’t compare Apples with Googles

New investors may try to compare the share prices of two different companies or exchange-traded funds (ETFs) to determine which one is a better deal. It’s both common and a mistake. Why? Because it’s not the share price but the total value of the company that’s important. Compare it to buying a banana for $10, rather than a new pair of shoes for $50 and thinking you got a bargain because you spent less.

Because companies often have high price tags (many on the US share markets are valued at over $1 billion - called a unicorn 🦄), it’s near impossible for one person to own the whole thing. So they’re broken up into shares, allowing thousands of investors to have a slice. There are no rules around how many slices a company can be broken up into, so a higher share price could simply indicate that each share represents a bigger company slice. 

Share price x number of shares = value of the company

What does that mean for investors? Comparing shares based on how much they cost doesn’t make a bunch of sense, you could even say it’s totally bananas... You would be better off learning how to calculate the value of shares in a company, which is a more meaningful way to find the intrinsic value of a stock.

Don’t sweat the share price

Waiting until the time share prices are ‘perfect’ (aka trying to time the market) keeps you on the sidelines. Many say ‘it’s time in the market, not timing the market’ that matters. In fact, the investment strategy most recommended for beginners is to buy and hold a diversified mix of shares for the long term. Could you save money staying on the sidelines? Maybe. But the one thing you’re guaranteed not to gain back is your time.

Now you’ve gone through the basics of how a company's share price is determined, how supply and demand can have an impact, and the roller coaster of prices (and emotions!) that come with it, you’ll be better placed to avoid buying that $10 banana and choose shares in a company or ETF where you understand their value.