Stock prices are primarily driven by the expectations that investors have for the amount of money they can reasonably expect to earn through the shares of businesses that they own. Specifically, businesses that have raised money in the past to fund their growth by selling off portions of the ownership of the business to investors in return for a share of the profits that they expect to sustain in the future.
The sustainable portion of a business' profits that investors can reasonably expect to earn through their ownership of the share of the business are called dividends, where the business' primary owners periodically divide up a portion of the profits earned by the business and pay them to out to investors in direct proportion to their share of ownership in the business.
Consequently, what investors expect to earn through dividends at the specific times in the future at which they will be paid can have a profound effect on stock prices. If investors believe that they can earn a growing amount of dividends in the future by owning shares of these equity-financed businesses, they will bid up the price of the shares of ownership to buy them from their current owners, who might wish to pursue other opportunities with the funds they gain from selling their shares. And vice-versa for the opposite scenario, where the current owners might greatly wish to pursue other opportunities and need to entice other investors to buy the shares they want to sell by lowering their price.
Now that we've laid this basic groundwork for the fundamentals of what drives stock prices, let's get to the revolutionary.
The change in the growth rate of stock prices is directly proportional to the change in the growth rate of the dividends per share expected at specific points of time in the future - or as we've observed, at a specific point of time in the future to which investors have fixed their forward-looking focus for setting their expectations of it while making their investing decisions today.
That means that there are two fundamental ways in which stock prices can change. The first is pretty obvious: They can change as the amount of dividends expected to be paid in the future changes.
Political Calculations is a site that develops, applies and presents both established and cutting edge theory to the topics of investing, business and economics.
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