What fuels demand for a stock?

Wall Street has said for years that the market is efficient, and the price of a stock represents everything that is known about a company up to that moment. Wrong, stock prices over-react to news, both good and bad.

You would think that if a stock is fairly valued, that no one would buy at a higher price or sell at a lower price.

But how can anyone truthfully say what fair value is? Sure, you can measure stocks by earnings, dividend yields, return on invested capital, the company’s growth rate, or against its industry peers. Some experts say that since safe government bonds sell at about 20x earnings (at a 5% return), stocks should sell at less than 20x earnings because of the added risk, and many of course do.

The fact is, stocks don't have a “fair value”, and they never have. The buying and selling, and so the moment’s price, is driven by psychological forces (fear of lost opportunity, envy over the killing that a friend made in the market, good news, bad news) and economic forces (productivity, inflation, deflation, etc.). It’s what the crowd thinks about all of this that creates demand or a lack of demand.

Whether it’s because of a company’s growth or “because it’s a big company that pays a regular dividend”, big demand for a stock comes down to one thing, and only one thing: investors think that they will make money by buying the stock. Period.

The Beardstown Ladies Investment Club (of Illinois) sold a lot of their books and received lots of publicity when they reportedly earned 23.4% for 10 years. Turned out that they didn’t know how to figure percentages, actually earning an annual average of 9.1% while the S&P 500 averaged 15.3%

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