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How Is a Company’s Share Price Determined?

Supply and demand drive any market in the world and the stock market is no exception. When a company sellsitsstock in the market, itreceivesmoney from the buyer as share ownership. Now the price at which the company sold its share becomes the new market price.

When you analyze the market, you’ll see that whenever the demand increases the price of the shares also increases.If you put this statement intheoretical form,you can say that IPO or an initial public offering of a stock is equal to the anticipated future dividend payments. Also, it means that the stock’s value fluctuatesaccording to changes in supply and demand. Numerous market factors and forces reflect on supply and demand. Therefore, if you want to calculate the stock price, evaluating the supply and demand would be a wise choice.

Company Value and Company Share Price

You can easily understand the law of supply and demand. However, calculating supply is easierthan demand.An investor knows techniques and tools to analyze and find a company’s worth. But, how can you identify the value of a company’s share while investing?For instance, the current Oxford Biomedica share price is 1522 as of November 2021. But, how did investors find the right share price of this company?

The current earnings of a company are the major factor to understand how much profit it makes. But,sometimes investors focus on more than numbers. Keep in mind that the stock price reflects on the company’s current value and prospects. The investors anticipate the future growth of the company.

Company Share Price

Investors can calculate the company share price by visualizing the price indices on national and foreign stock exchanges. They consider the daily closing value for a month and determine the average. The change in the stock value index can be found through the share price index. With the help of this index, you can identify the company’s returns. This indicates how much money you might make by investing in the company’s share.With the price index, companies measure the market capitalization for shares as well.

Understanding Capital Markets

To understand the stock prices, you need todetermine the capital markets. Experts refer capital market as “Wall Street”. The two major capital markets are:

The Primary Market

This market enablesbusinesses to connect with the investors so they can thrive by raising their capital.

The Secondary Market

These markets are complementary to the primary market and facilitateexisting owners who already have stocks and bonds. In this market,stockholders can offer securities toother investors.

Predicting a Company’s Share Price

Numerous techniques, models, and formulas are available for investors so they can anticipate the future share value of the company based on the current situation. Different experts constructed these formulas so investors can easily evaluate the market condition and make an informed decision.

There are dividend discount models that consider the current price value and calculate it by adding it with future dividend payments. These models use the time value of money theory to calculatea company’s value byadding the expected future dividends together.

The Gordon Growth Model

There are wide ranges of dividend discount models in the market. These models help investorspredict the company’s stock value and dividends. TheGordon’s growth model is one of the most popular and straightforwardmodels among them. Myron Gordon, a U.S. economist constructed this model in 1960. The equation of the model is:

Present value of stock = (dividend per share) / (discount rate – growth rate)

Or, as an equation:

P=D1/r−g

In this equation:

  • P is the Current Stock Price
  • G is the Constant growth rate for the dividends
  • R is the Constant cost of equity capital
  • D1 is the Next year’s dividends value

Example of a Share Price Valuation

Let’s understand the equation with an example. Alphabet Inc. is trading the stock at $100 for each share. Suppose they requiretheir minimum rate of return (R)to be at 5%. What’s more they currently pay a dividend of $2 per share, which would be D1. The increase in the dividend per share is expected to be a 3% annual increase, which would be G. Then the current stock price of the company would be:

$2 / (0.05 – 0.03) = $100

Gordon Growth model suggests that the investors should calculate the company’s value with the current values. For instance, if the company is trading at $125 per share, itsovervalued price would be 25%. On the other hand, if they will trade with$90, their undervalued price would be $10. Many investors will consider this as a buying opportunity. For instance, if you look at the IQE share price chart, you’ll find that their undervalued share price issuitable for purchasing.According to experts, these kindsof markets will drastically increase in the short run.

Conclusion

The above-mentioned model has a similar structure to perpetuity and helps investors identify the current market value. Perpetuity is a cash flow cluster that consistently calculatesthe stock amount with an end date. We know that companies won’t sustain this for a long period in real life and their growth might fluctuate within time. Their stock dividends might increase or decrease and might not remain in constant form, which is wherethe Gordon growth model may come in handy.

It is also worth keeping in mind that many companies don’t share their dividend with investors. Therefore, finding the price value is merely anticipation. It just helps investors make well-informed decisions.

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