One of the hardest concepts for beginners to understand is how stocks are valued. What is the driving force behind a stock price and what causes some stocks to be so volatile? When you buy a stock, you are buying a part of a company. However, that stock price of that company can go up and down drastically sometimes for almost no reason which in turn means the value of the company is going up and down as well.
Lets pretend you bought some shares of the stock Garmin in the last six months. If you were unlucky and bought it at its high, you might have paid as much as $125.00. Unfortunately if you look at the stock price today, you will see that the price is down to around $47.00. That is a decline of more than 50%! This also means that the value of the company went down more than 50% as well.
What happened? How can a company be worth only 50% of what it was just 5 months ago? Is the company really in that much trouble? Did a hurricane destroy a factory or two? Well, in Garmin's case it is all because the perceived value of the company went down. GPS devices have been very hot for the last 3 years or so and the stock went up steadily because of the perception that Garmin was the industry leader and would sell a lot of units.
Suddenly, with the economy on the downturn and people not spending as much as they did for expendable items, the perception is that Garmin will not sell as many units in the coming years. The company is still doing well right now but everyone believes that things will change. Thus, just because people THINK things might change, the stock goes down and so does the value of the company. The perceived value of the company has gone down.
Stocks can shoot up for the opposite reason when people think a company is in the sweet spot and has a product or technology that will do very well in the future. In that case, the company stock may go through the roof even though they have few sales at this very moment.
Stock prices go up and down daily on what stock market investors perceive the value to be and not necessarily what the company is really worth. It is difficult to fathom this sometimes because you have to change the way you think about investing in stocks. This is another thing that shows that the stock market for beginners is a complicated beast to learn.
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