What is a Share Price?
Share price is the value placed on a company’s stock. Publicly held organizations will sell shares of stock to increase capital reserves through equity investments. Initially, companies will go through a process known as an initial public offering. A financial services underwriter will place an initial share price on stock based on current market conditions and the company’s current financial position. After the initial offering, the company’s stock price will rise and fall based on the demand for the company’s stock.
Setting share price for issuing stock is not an easy process. The underwriter will often review past stock issues for similar companies and review current market conditions prior to issuing a company’s stock. From this information, the underwriter will come up with a range for the stock price, such as $12 US Dollars (USD) to $15 USD. This gives potential buyers an idea of how much they will pay to purchase the stock. If high demand is available for the new stock issuance, the share price can increase tremendously throughout the day of issuance as more investors desire the company’s stock.
While the price listed on the stock exchange is the market price at which investors will buy and sell shares, it is not necessarily the book value of the company’s shares. Investors will often compare the book value per share to the market value per share to determine if a premium exists. For example, a company has $1,000,000 USD in total assets, $500,000 USD in total liabilities, and 100,000 shares of outstanding stock. The book value of the company’s shares is $5 USD. If the current share price in the market exchange is $7.50 USD, then the company’s stock is trading at a $2.50 USD premium compared to book value. A company that's stock is less than book value is not generally seen as a good investment.
Another view on share price is the price multiple at which the stock is valued. A common formula to calculate this figure is the price to earnings ratio, which is the market price of a share divided by the earnings per share reported by the company. For example, stock with a market value of $45 USD and current quarterly earnings per share of $2.50 USD means the stock’s multiple is 18. If the company reports its next quarterly earnings as $2.75 USD, the investor can multiple the earnings per share by the multiple of 18, indicating the share price should increase to $49.50 USD, resulting in a gain of $4.50 USD on the stock.
@everetra - I’d love to get my hands on another IPO. I realize we no longer live in an Internet bubble, but there are still a few opportunities out there. The problem with most IPOs is that it’s not normal folk like me who get first dibs on the shares.
It’s the angel investors, bankers and other equity firms that lent substantial capital for the startup to get going. These institutions took significant risks, and of course they want a piece of the action when the company finally goes public.
By the time the little guys get the stock, it may have already peaked in value, at least for the short term.
@miriam98 - Well, it was a lesson learned I guess. A lot of people were in your camp. Some companies, even today, still seem like a sure thing however.
One example is Google. The Google share price has always been in the hundreds of dollars. However if you follow the chart you will see that it can experience wild swings in the course of a year or two.
If you sell at the wrong time, you could still lose money, although the company as a whole still continues to do well. So there is no sure thing after all.
I like to buy value stocks. This doesn’t necessarily mean that they are cheap, but that they have relatively low multiples or PE ratios. This means that it won’t take long for the company to earn back the money you put into buying their shares.
Companies with high PE ratios, conversely, may take a long time to earn back your initial investment. Of course most of them never do. What happens is that the stock price comes crashing down to more reasonable levels.
This is what happened during the Internet bubble. PE ratios were sky high; many naive investors, instead of buying low and selling high, bought high with the hopes of selling higher! They were sorely disappointed in the end. I know. I was one of them.
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