Stock prices fell, leading to bear market conditions on some major exchanges.
Understanding how stock prices work is important to understanding current market conditions.
Michael Axel, President of AMI Investment explained it this way:
“Stocks are valued based on their discounted future cash flows,” he said. “For example, if Company A produces $10 per year of free cash flow and Company B produces $5 per year of free cash flow, Company A should be worth twice Company B (all other things being equal otherwise).
“If company A is trading for $100 (10 times free cash flow) and company B is trading for $90 (18 times free cash flow), you conclude that company A is a better deal than Company B (all other things being equal).”
From there, Axel’s explanation becomes a little exhilarating.
“Future cash flows are discounted to their net present value using a risk-free discount rate,” he said. “Without going into too much detail on discount rates, the bottom line is that when interest rates go down, the discount rate that you use to calculate the net present value of future cash flows goes down, which makes future cash flows more valuable When interest rates rise, the opposite is true The discount rate increases, making future cash flows less valuable Stock prices are affected by a number of macro and micro factors, but the main drivers of stock valuations are future earnings and interest rates.
Edison Byzyka, chief investment officer at Credent Wealth in Auburn, offered this description of stock values.
“Stock prices are often determined by a company’s anticipated future earnings potential, not the current state of the company,” Byzyka explained. “As an example, if Apple Computer is showing record revenue today (very positive), but tells us that revenue in future quarters may be lower (not as positive), the stock will experience a significantly higher volatility profile. None of this means that their products are obsolete, but it provides for a reassessment of the earnings multiplier that investors are willing to pay for each share of the stock.
“After all, stocks are driven by their price-to-earnings ratio,” he said. “If earnings are expected to be potentially lower, this ratio will adjust immediately even if the further revenue decline has not been announced. Depending on earnings forecasts that Apple or Nike can provide , the volatility profile will reflect this assessment.Inflation has also been a near-term detractor of sentiment for companies like Apple (a large growth company) and Nike (a large consumer discretionary company). investors that we have not yet reached the peak of inflation, then conventional wisdom suggests that companies will generate less revenue within a supply chain that now requires higher input costs. higher labor costs in today’s labor market.