1. INTELLECT
What Do Share Prices of Companies Reflect?
There is a difference between the price of a share and its intrinsic value. This is because while the share price represents a company's
valuation, it is dependent on several macro-economic factors as well. So it is not just the performance of the company that matters.
Also when the profitability and outlook of profitability comes down, the price can follows suit because “price of the share of a
company” is a function of profitability expectation of that company. Below are the various parameters that have a bearing on share
prices.
1) Inflation: When inflation is high, people have less money to buy goods. Hence the demand for goods and services comes down.
This reduces profitability of companies which in turn brings down the price of shares. Also when inflation is high, the input costs
for companies soar and many times companies do not pass this increase on to consumers. At such times, the company takes a
hit by way of margin squeeze which brings down both profitability and share price.
2) Interest Rates: When interest rates go up, companies are directly impacted as their interest costs increases. This may bring
down profits and the outlook of future profits if the high interest rates are expected to sustain. When profit outlook comes down,
the share prices too tend to move down.
3) Currency Devaluation: When currency gets devalued or expectations of devaluation sets in, the interest of foreign investors
could start to decrease. For example, if an international investor invests $100 when the value of the rupee was Rs 50 (this means
the person bought Rs 5000 from the $100). Subsequently if the value of the rupee decreases to Rs 55 to a dollar, then one can
only recover about $90 from the Rs 500) which one purchased. Thus the returns are adversely impacted in a depreciating
currency scenario. Hence during such times, foreign investors are hesitant to invest and cause foreigners to sell off Indian
shares, converting the proceeds into dollars and fleeing Indian markets. This sale of shares initiated by them would bring share
prices down.
4) Government Spending: A government that borrows in excess and overspends reduces the money available in the system.
Private companies either have to make do with limited finance which hampers its growth plans or it has to borrow at higher
interest rates which brings down its profit growth outlook and hence its market capitalization (price). This phenomenon is what
is popularly termed in finance as “crowding out” of private investments. Also one must understand that overspending on part of
the government can lead to inflation if the supply of goods and material is inadequate. Inflation itself has an adverse impact on
share prices as explained in the section on “inflation”.
5) Fiscal Deficit and Current Account Deficit: When the government spends more than it earns (imports more than it exports), it
has either borrows at higher prices which raises interest rates in the economy or it has to print notes to meet the deficit. In the
case of printing currency without equal economic activity, the value of money goes down or in other words “inflation” kicks in.
Thus higher interest rates, inflation and devalued currency impact cost of input and demand of goods and services unfavorably.
This impacts company profitability and brings down share prices.
There are several macro-economic factors that influence share prices. Secondly, these factors are inter-related and these factors
play a vital role in creating negative or positive sentiments among investors as the case may be. So even if a company is performing
steadily and having reasonable operational profits, the macro- economic outlook plays a significant role in determining its share
price.
Disclaimer: The views expressed in this lesson are for information purposes only and do not construe to be any investment, legal or
taxation advice. The contents are topical in nature and held true at the time of creation of the lesson. This is not indicative of future
market trends, nor is Tata Asset Management Ltd. attempting to predict the same. Reprinting any part of this presentation will be at
your own risk. Tata Asset Management Ltd. will not be liable for the consequences of such action.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.