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Let us start from the old times, where markets were less liquid. Suppose I hold some stocks of the company XYZ and I want to sell them. Why shall I expect that their price can rise in the next quarter given that company showed good in the current quarter and is likely to do well in the future? I could name at least three reasons for that:

  1. The dividends on these stocks will be higher

  2. If I own enough stocks, the buyer of them can play a role in managing the company

  3. The buyer of stocks will expect that the price will grow even further and wants to speculate on the stocks by selling them for a higher price, say, in a year.

The latter reason is a bit cyclic though: if it would be the only reason to buy a stock - then the only thing determining the price direction would be the expectation of market participants - even not about the company itself, but about the price direction. As a result, in such situation I would not see any connection between the fact how the company does, and how the stock price changes.

At the current moment, there are a lot of companies that do not pay any dividends on their stocks, and there are a lot of investors that buy/sell stocks of these companies in amounts much less to talk about affecting the company's management. I wonder thus, whether for such companies there is no any connection between how company does, and how the stock price moves. Perhaps, that could be illustrated by a dotcom situation 15 years ago. By a fundamental reason for a price change I mean something that does not depend only on the expectation of the market about the stock's price, and is related to the company itself.

Edited: I've just found a very nice and useful discussion here which almost answers my question. At the same time, I would be happy if a more quant-oriented community says its word.

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2 Answers 2

Its a bit of a broad and almost philosophical question to be honest. Just two things that pop in mind are (A) the money supply (& possible inflation) in combination with interest rates - this will drive the major money allocation in the world. As you see now with S&P at record highs on the back of massive quantitative easing and low interest rates. Money has to go somewhere (for fund managers and the likes) to bring returns. (B) mergers and acquisitions - major driver for some hedge fund plays on relative valuation of the stock prices of both companies.

But then again, just two things (of many more) that pop up...

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Thanks a lot - acquisitions is something that slipped away from my mind when I was thinking about the question. –  S.D. Sep 25 '13 at 9:02

In general, from a fundamental analysis viewpoint, a good buy would be a stock, whose price is lower than its fundamental value. In Rational Expectations theory, all future payments are already correctly priced into the stock price, so (1) an assumed rise of dividends, which you mention, would be already reflected by the stock price. If not so, you could arbitrage on that mispricing. (2) makes no sense, in my opinion, since, in general, the manager of the company has the best information set, so a participation of the stock buyer in the decision process would not necessarily lead to an increased value. (3) is most likely the motivation of a fundamentalist, but only if he thinks that he knows better than others. Anything else would be technical analysis, i.e. the assumption that future price patterns can be explained by the former price process. This is in contradiction with FA though, because, as explained earlier, that information would have already been processed. Look up "Efficient Market Hypothesis" on this topic. So, I think, fundamental reasons for a price change can only be explained by a current under-(over-)valuation of the stock, a trade of fundamentalists on this mispricing and a price correction in the future.

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one could argue, though, that the stock should earn its risk adjusted return and thus should increase in priceby this amount, but this function is ideally fulfilled by dividends, which again would result in constant prices –  Arne Sep 25 '13 at 14:03

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