Factors Affecting Stock Price - Research Proposal Example

Factors affecting stock price’ Name of Student: Institutional Affiliation: Table of contents Introduction 3 Purpose of the study 4 Importance of stock prices 5 Historical background 6 Globalization of the stock market 7 Theoretical background 8 Performance drivers 8 a)Basic variables 8 b)Short term and long-term factors 9 Internal Factors 9 a)Product cycle 9 b)Type of products produced and marketed by a company 10 c)Competition in the market 10 d)Presence of Markets in growth areas 11 e)Quality of Management 11 f)Monopoly and related factors 12 External factors 12 a)Inflation 12 b)Yields from bonds 13 c)Inflow of money into the stock market due to demand and supply forces 13 d)Liquidity and changes in the volume of trade 14 e)Institutional influences 14 f)Size of a company 14 Research methodology 15 References 17 Introduction Fundamental macro and microeconomic variables have been found to have significant effects on the stock market and stock prices. Since time immemorial, stock prices have experienced a remarkable change attributed to rapid economic development and the rapid growth of and capitalization of the financial markets. Many scholars and institutional investors have been focusing their attention on the factors affecting stock prices and the capital markets with regard to major economic activities. Presence of a well-established body of research on stock market prices coupled by empirical evidence gathered from economic activities has established that a number of factors affect stock prices. The stock market and prices have witnessed historic changes. The business of stock trade has evolved to an increasingly competitive activity and a range of new products have been introduced. Electronic platforms that facilitate trade in stocks and determination of stock prices have emerged making most exchange floors limited to large blocks of trade. Major forces of competition and opportunity have been at play in the determination of most stock prices. Financial technology continues to impact the rapidly changing landscape. As such, stock brokers have had the onerous task of ensuring that the functionalities and capabilities of their trading platforms equip them to compete on a global platform. The Internet and the email have become common technologies and our lives around the stock market environment and at home have changed drastically. Communication between and among people on a global platform has immensely been facilitated by ICT as people have been able to communicate irrespective of where they are, certainly, because ICT has created a global world where the capability to communicate has been made much easier, and faster than it was three decades back. Even though the technology is abhorrence to itself, the U.S., over the years, has maintained a leading position in the global economy because of its technological sophistication. ICT has enhanced chances of accessing and transmitting financial information and knowledge on stock markets from any point in the world which, in effect, enhances globalization of stock trade. Research has tabled findings suggesting that prices of most stocks have been changing or rising and falling which clearly demonstrate the need for this study (Cimoli, Andre & Mulder, 2010). Rapid growth and spread of information on stock markets and communication technologies has brought about major socio-economic progress. Most stockbrokers have used the Internet as a medium through which they locate and determine trends and other factors that are likely to shake most stock prices. Evidently, this can be credited to the breakthrough that ICT represents both as a techno-economic paradigm, and as a general purpose technology. This paradigm has the potential of fostering productivity growth, structural changes, economic and social development in most stock markets (Cimoli, Andre & Mulder, 2010). Purpose of the study i. To analyze the importance of stock prices on the performance of a company; ii. To analyze the historical background of stocks and the determination of stock prices; iii. To determine factors that affect stock prices Importance of stock prices Stock prices are one of the ways through which companies can raise their money. Stock prices facilitate the raising of supplementary financial capital which facilitates expansion of companies. This facilitates an exchange that allows and gives investors the reason to invest and to sell their securities. Stock prices grants attractive and an unattractive feature for a given investment and also to gauge the level of its liquidity (Baden, 2011). Historical evidence has laid bare the fact that stock prices and the price of other financial assets have an important contribution in the economical dynamics and activities which is an indicator of economic progress. Countries whose economies are market with a massive rise in the stock market and prices is said to be “up-and-coming” (Baden, 2011). Prices in the stock market are said to be an indicator of economic strength and the level of economic development of a country. When stock prices establish an upward trend, there is a high probability that business investment activities are on the rise and vice versa (Baden, 2011). Stock prices facilitate exchanges for transactions and various deals which also guarantee payment of securities. This eliminates risks inherent in the trade process. Smooth operations during the exchange process facilitate economic prosperity since lower risks and costs to enterprises promote the production process and creation of wealth and employment opportunities (Baden, 2011). Recent studies have pointed out the presence of a link between the money market and the stock market. This implies that if there is efficiency in the stock market prices, then equilibrium is created in the investment portfolio. Historical background The stock market is said to have been in existence for several years back. The first stock market institution is believed to have been created around 1531in Belgium (Antwerp). Before then, stock broking was a common activity but did not have a well-established institution. The existence of the institution roughly approximated the stock market. The activities of the stock market institutions at this time were limited to business deals and personal debts and not company shares since they did not exist (Rik & Scott, 2007). Since time immemorial, trade in stocks spread to other countries like India and USA and to cities like Rotterdam, Amsterdam, New York, among others. The American stock market, for instance, has been in existence for more than 2 decades. It originated with a handful of brokers that met outside one of the streets in New York. Today, most stock markets have grown to become some of the most important institutions of finance in the 21st Century. The history of the stock market began around the late 1700s. This was facilitated by an organized auction market that traded commodities on the Wall Street in the lower parts of the New York City during this time. However, the trade on stocks as was determined by certain market forces, alongside other factors, did not include securities or stocks as they are known today (Rik & Scott, 2007). In 1790, Alexander Hamilton by virtue of his financial and political power came up with many dramatic changes. Some of these included an issuance of the government securities which later sparked trading them all over the country and in New York (). This enhanced trade in bank stocks. As such, the financial markets in New York shot to fame over rival markets in Philadelphia and Boston (Rik & Scott, 2007). During this time, trading in stocks and the determination of stock prices were unstructured. Auctioneers could call out prices for stocks deposited with them for sale and there was no set process or time for deals to close or for trades to take place. Newspapers carried reports on securities, stock sales and stock prices at 22 Wall Street (Rik & Scott, 2007). After a number of years, business and trade in stocks has improved and covered a variety of financial items. Growth and investment in activities and the markets have been progressing along with the economy. As competition increases, a number of rules have been created to govern the trading process. Today, stock markets have developed and have been established virtually in every in every developed, and in the infant economies. Globalization of the stock market Since 2011, there has been an apparent acceleration in the pace of globalization of stock markets. This has been marked by a flurry of takeover and mergers which serves to reinforce the process. Globalization in stock market and prices has been facilitated by advances in communication technology and trading which have induced important changes in structures that govern exchange ownership and organization of stock markets (Poitras, 2012). According to Poitras (2012) “the globalization process has produced historic changes in the structure of stock markets.” Countries and states belonging to particular regions have achieved contemporary globalization in most of their economic activities. In the Middle East, for instance, there is the universalization of a liberalized and capitalist economy which is a familiar model in both local and global economic relations, and the related ideological problems for the liberalization of policymaking and the increase in the speed and pace of expansion and use of modern technologies to communicate. Participation in stock brokerage has been a major motivation for most investors in countries with favorable investment climate in the quest for economic development. In the Gulf Region, the production of energy resources facilitated and attracted investment of its profits abroad (Poitras, 2012). Theoretical background The stock market is a place where stocks are sold. Stocks are partial ownerships of companies and are sometimes called shares. Shareholders in a given company can hold one or more shares of that company. Investors buy shares of a company when stock prices are favorable. A number of factors, both internal and external have been found to influence and/or affect the performance and behavior of stocks. However, the relative importance of the factors that have been identified may vary from one case to another. The extent at which the factors identified below have been covered and the degree to which they have been analyzed may show significant variations. The following factors have been established to have significant and profound effects and changes in stock price. Performance drivers a) Basic variables Various variables such as the prevailing interest rates, corporate profits, inflation and the economy have been shown to affect the performance of the stock market. This can be tied to the above factors. This implies that any development that exposes a given company or firm to several risks in the realization of its future profits is likely to cause a reduction or decline in the stock prices. Contrariwise, any development that leads to or is perceived to lead to a reduction in the risks for a given company increases the stock price (Zuberi, 1998). b) Short term and long-term factors According to Poitras (2012), short and long range factors have been established to have a profound effect on stock prices. Moreover, these factors can also significantly influence the direction taken by stock prices in the short-term. These factors have been identified as trends in the rate of interest, the internal momentum that exists in the market and various sentiment factors that are related to the investor. In the long-term, appropriate modalities that provide a realistic basis in the valuation of individual stocks and in the determination of stock market prices may lead to a positive direction of the market as well as the stock (Zuberi, 1998). Internal Factors Many factors that are related to businesses and which have a direct impact on a company’s primary business may also affect its business prospects, profitability, its operations and viability. These have been discussed as follows; a) Product cycle Many companies are over-concerned with innovation and introduction of new products on a regular basis since they want to maintain a competitive edge over rival companies. To realize profits and to establish a good brand reputation, a company must plan how and when it releases its products according to the requirements of its market (Baden, 2011). When the company manages to secure a strong product cycle when it plans to release its products to the market, there are high chances that it will generate revenue streams from its products in line with their release which can affect profits and stock prices. This can be attributed to the fact that the market anticipates a growth in revenues. An example of a company that thrives on this idea is Intel which has been introducing new products within a short product cycle. However, companies that delay or have poor product cycles may fail to secure a reliable consumer base leading to a drop in stock prices and consequently low profits and even going out of business (Baden, 2011). b) Type of products produced and marketed by a company Stock prices can also be affected by the ability of a company to sell its products which in turn determines the level of profits, the revenue generated and the rate of growth. Most companies that have emerged successful and profitable are those that produce innovative and competitive products and continue to do so consistently (Baden, 2011). As such, stock prices of such companies may appreciate and they may be handsomely rewarded through the appreciation of stock prices. This implies that for a company to realize profits and to remain competitive in a dynamic market, it must remain innovative with the kind of products it offers to the market (Baden, 2011). This also places the need for the company to diversify its line of products so that it is less vulnerable to market risks when one or more of its products fail to capture and meet the needs of the target market. c) Competition in the market Competition has been established to have profound effects on stock prices of most companies. In most cases, the entry of new competitors in the market has been a big trouble for most companies, especially the profitable ones. This is because fierce competition from the new company compels the old or existing company to lose its market to the powerful competitor. This means that the company will have to struggle or adopt punitive measures to survive. As such, it can decide to lower its stock prices to attract other investors so that it can enhance its operations. d) Presence of Markets in growth areas Companies that are established in a given growth area have the opportunity and chance to hit higher sales records, earnings as well as high stock prices and vice versa (Zuberi, 1998). Growth areas can be fast growing markets especially in other countries or regions that have a remarked absence of the product that is produced by the company. Such companies are likely to experience phenomenal growth and realize high profit margins which in turn lead to high investor confidence and thus high stock prices (Baden, 2011). e) Quality of Management With good managerial practices in place, a company is likely to thrive due to adoption of sound mechanisms of operation on a daily basis. This is informed by good judgment and prudence in the making of decisions. Without sound and proper management, it may be difficult for a company to thrive and to realize profits. This has a much profound effect on how the stock and thus stock prices of the said company will perform in the stock market. This idea can be validated by the presence of profitable companies that have been tumbled-down by poor managerial practices. As such, prudent and acceptable managerial characteristics have been a notable factor of consideration by most investors when analyzing companies. Such factors include integrity, willingness of the company to invest for the future, ability to execute its plans, main focus on making correct and prudent business decisions rather than seeking cheap publicity stunt for instance on Wall Street, a good success record and open communication with the people (Zuberi, 1998). f) Monopoly and related factors Companies that have a perfect and secure grip of the niche markets can be very profitable. This can be healthy for their stock prices. Small companies that have been able to monopolize a given niche market through sale of a unique product or a large share of the market is likely to generate heft and consistent profits which drives up its stock prices. External factors These refer to environmental factors which affect the core business of a company. In turn, these factors affect the company’s business prospects, operations and profitability. Such factors include; a) Inflation During inflation, interest rates fall. This also affects the money market. The rate of economic growth slows down, negatively affecting stock market prices. A rising inflation is unhealthy for most stocks since there is the perception that the earnings growth of a given company, in most cases, will be inadequate when offsetting the higher rate of inflation (Zuberi, 1998). As such, what the company is likely to earn in the future will be diluted by inflationary forces, and consequently, prices of stocks which are negatively impacted. This implies that the corporate earnings for the said company will fall which may also not attract investors. The company will therefore struggle to stay afloat by shifting a flood of cash into mutual funds and stocks due to low rates of saving (Zuberi, 1998). b) Yields from bonds These have a preponderant effect on the price and the behavior of most stocks especially those that are correlated with bond yields (Baden, 2011). Effects from bond yields, oftentimes, is temporary as the ultimate and determinant factor of stock prices, in most cases, is profitability. c) Inflow of money into the stock market due to demand and supply forces Stock prices may appreciate when there is more inflow of money into the stock market. Therefore, there may be more money available for a limited number of shares. This leads to a flood of cash which pushes stock prices higher. The factors of supply and demand may affect the way in which stock is valued since many investors desire to own stocks whose demand outstrips supply since there is a high probability that they will experience an invariable rise in share prices. Most investors tend to be well aware that any slight change in supply and demand may lead to fluctuations in share prices. This means that when there is a high demand, then stock prices may rise and when the supply increases, stock prices are depressed (Zuberi, 1998). The supply of stocks is determined by the number of shares that have been issued by a given company on a particular day which is made available to investors. However, when the management of the company is restricted to sell shares during a particular time due to the rules of the company, then the supply of such shares will be limited hence their demand will skyrocket leading to high stock prices (Baden, 2011). d) Liquidity and changes in the volume of trade When markets are on a downward trend, the liquidity of stocks can be a problem. Against this background, few buyers would be available to buy stocks. As such, investors may realize unfavorable trading volumes which may be associated with special circumstances. Any increase or decline in stock prices can be associated with either an increase or a decrease in the volume of stocks which may be bullish and not bearish (Baden, 2011). e) Institutional influences Large institutions have been found to have an influence on stock prices since they have been major investors in many stock markets. Before they invest in any company, large institutions normally look at the trade volume of stocks on a daily basis and its float while avoiding any investment in a trading volume below a number of shares in a given day. This is because some of them prefer high share volumes since this is an indication of high liquidity which, in the short term, will enable them to exit quickly from a stock since this can induce a large drop in prices (Baden, 2011). f) Size of a company Companies that have large floats of millions of shares, oftentimes, do not make big moves in prices since they require remarkable buying and selling due to their inertia (). Smaller stocks are much easier to move as compared to big stocks. As such, when smaller stocks get the attention of established investors, the demand for such shares and consequently stock prices, will rise significantly (Baden, 2011). Research methodology Data will be derived both from primary, and secondary sources. Primary data will originate from one-on-one interviews with subjects, and through executing a survey using both quantitative and qualitative research instruments (Mixed methods research). Turner (2007; cited in Creswell & Vicki, 2010) define mixed methods research (MMR) as “the type of research in which a researcher or a group of researchers combines elements of quantitative and qualitative research approaches (e.g. use of quantitative and qualitative viewpoints, data collection, analysis, inference techniques) for the purposes of breadth and depth of understanding and corroboration.” A proper and more acceptable definition of mixed methods research has been based on different paradigms which have been disputed by some authors on a number of grounds (Creswell & Vicki, 2010). Creswell & Vicki (2010) opined that this method gathers and analyzes rigorously, and persuasively, both quantitative, and qualitative data using procedures framed within theoretical lenses, and philosophical worldviews. Therefore, it will be appropriate and suitable to mix both qualitative and quantitative methods due to fundamental differences (incommensurability) in the variables that are being investigated, i.e. factors that affect stock prices (Tashakkori & Charles, 2010). Against this background, as cited in Tashakkori & Teddie’s study (2008; cited in Tashakkori & Charles, 2010), Mixed Methods Research (MMR) approach, in its methodology, is touted to be the best as it gives the researcher much freedom to choose what he or she believes are the best tools to answer questions. According to Tashakkori & Charles (2010), “MMR can simultaneously address a diverse range of confirmatory and exploratory questions, while single-approach studies can often address only one or another.” Properly conducted, MMR also provides the opportunity for an assortment of divergent conclusions and inferences due to the complexity of the data sources and analyses involved in the results. A survey was chosen as it will give the researcher ample time to sample a large population of respondents, to analyze the variables, to test the hypotheses, and to interpret the findings to obtain a more valid and objective outcome. However, the measurement instruments (especially in the determination of stock prices) may have diverse advantages and disadvantages. Some merits of the survey technique include speed of development and ease of implementing the approach. However, it comes with drawbacks such as the respondents might give biased answers while others find it uncomfortable to reveal their information that represent their companies in a negative manner. On the other hand, the interviewing measurement method has a variety of advantages that include ease if reaching a wide range of respondents, it can reach hard to reach people if they have an internet of phone connection and respondents might find it comfortable to give response concerning sensitive information through the interview. However, interviews have many drawbacks such as the high cost of gathering data and booking appointments with prominent people (University of the Pacific & International Institute of Philosophy, 2012). References Baden, B. (2011 July). 5 Factors That Drive Stock Prices Central banks, market sentiment, and valuation all play a role, retrieved, 16 June, 2014, from http://money.usnews.com/money/personal-finance/mutual-funds/articles/2011/07/14/5- factors-that-drive-stock-prices Cimoli, M., Andre, A.H. & Mulder, N. (2010). Innovation and Economic Development. New York: Edward Edgar Publication. Creswell, J.W. & Vicki, P.C. (2010). Designing and Conducting Mixed Methods Research. New York: SAGE Publications. Poitras, G. (2012).Handbook of Research on Stock Market Globalization. Massachusetts: Edward Elgar Publications. Rik, W. & Scott, E.H. (2007). The stock market: A Brief History. New York: Greenwood Press. Tashakkori, A. & Charles, T. (2010). SAGE Handbook of Mixed Methods in Social & Behavioral Research. New York: SAGE Publications. University of the Pacific & International Institute of Philosophy. (2012). Pacific philosophy Forum, 12(6) Stockton, Calif.: University of the Pacific Philosophy Institute. Zuberi, A.KV. (1998). Stock Investing for Everyone: Tools for Investing Like the Pros. New York: Bookworld Services. Read More