The Influence of Trading on Stock Prices: Unchanging Prices in Hypothetical Scenarios
Understanding the dynamics of stock prices is crucial for anyone involved in the financial markets. This article delves into the concept of stock prices in a scenario where no trading occurs, emphasizing the impact of supply and demand. We will explore real-world examples and explain the differences between stock price and value.
Introduction: The Impact of Trading on Stock Prices
In the hypothetical scenario where no one buys or sells a specific stock, what should we expect in terms of pricing? According to the basic principles of supply and demand, stock prices are influenced by the number of buyers and sellers in the market. Let’s discuss a real-world example to better understand this concept.
A Practical Example: When Trading Ceases
The story of Cipla in 1986 provides a fascinating real-world example. At that time, the company was a strong performer with earnings per share (EPS) projected to reach 400 rupees and a book value of 2100 rupees per share on a 100 rupee face value share. Additionally, the company had a track record of issuing bonus shares, which shows a positive track record among investors. Despite these favorable indicators, the stock faced a deadlock in trading, as no one was willing to sell.
I reached out to an Ahmedabad broker who found a shareholder willing to sell 20 shares. We agreed on a price, which was three times the last quoted price, at 300 rupees per share. Over the following days, the price started to jump, reaching 1300 rupees. This example highlights the unstable nature of stock prices when no transactions occur.
Understanding the Price and Value of a Stock
When someone says the stock price, they can mean several things. On any stock exchange, there are three important factors: the Bid Price, the Ask Price, and the Last / Mark price.
Bid Price and Ask Price
The Bid Price is the highest price that an unsatisfied buyer is willing to pay for the stock. Conversely, the Ask Price is the lowest price that an unsatisfied seller is willing to accept for the stock. The Last or Mark price is the most recent price at which a bid and an ask were matched, meaning both the buyer and seller were satisfied.
The Last / Mark price is often referred to as the “stock price,” but it is essential to recognize that all three prices are valid measures of a stock’s value. These prices are determined by the actions of potential buyers and sellers and are heavily influenced by the company’s profits but are not solely dictated by them.
Company Profits and Stock Value
While a company’s profits can positively influence its stock price, they do not guarantee an increase. For instance, a company can report strong profits but still face a stagnant stock price if buyers are not willing to pay more. Similarly, a company can incur significant losses, but the stock price may remain stable if no existing shareholders are willing to sell.
In a practical scenario, a company’s strong profit can attract more buyers, driving the Ask price up. This increase in the Ask price can reflect the belief that the company’s value has increased. However, if no buyers agree to pay the higher price, the stock price (the Last / Mark price) will remain unchanged. This scenario suggests that the potential buyers do not perceive the company’s value as having increased.
Exchanges and Market Prices
It’s also important to note that there are multiple stock exchanges, each with its own listing of stocks. The flow of information in modern markets is so efficient that these differences are usually not significant. However, for thinly traded stocks, the differences in exchange prices can be more pronounced. For example, the same brand of milk can have different prices in different stores, a concept that applies to different stock exchanges.
Theoretical scenarios exist where two individuals can buy and sell stocks and report the transactions a couple of days later. These transactions would be considered a part of the market. However, in practice, such transactions are unlikely to have a significant impact unless one of the individuals is a well-known investor like Warren Buffet.
Conclusion
In summary, while a company’s profit can positively influence its stock price, no trading activity can result in an unchanged stock price. The value of a stock, however, can increase if profitability attracts more buyers. Understanding the nuances between stock price and value can help investors make informed decisions in the dynamic stock market.