What factors drive share prices higher?

22nd December 2011

Of course, the array of dire stories hitting headlines has a severe impact on market volatility.  If it's not the Eurozone crisis, then it's ongoing gloom and doom across the UK and the rest of the world…

But aside from the wider economic picture, are there other factors that are more appropriate to consider? After all, none of us know what's going to happen in the current climate, and making predictions is a fool's game – and for those of us after long-term profit potential, sudden shocks are almost inevitably on the cards.

David Kuo from The Motley Fool says: "…if you don't look past the media hoopla and doom-mongering, you could be making a critical investing mistake. Investors that continuously put too much emphasis on short-term events end up trading too often and severely damaging their long-term returns. It's vital to concentrate on what really drives investment performance."

So what does drive investment performance?

Kuo stresses the companies and people behind the shares as the factors to consider. "Firms with a sustainable competitive advantage, great management, super prospects, and a share price that enables you to buy into the good earnings that you see coming in the years ahead," he writes.

The factors worth considering, behind the headlines are:

Does the company have a sustainable, competitive advantage?

Does it have attractive future business prospects?

Does it have a share price that lets you buy into future earnings' growth?

Does it have a solid, experienced management team you can trust?

…and are people buying?

According to Brian Dennehy from wealth manager Dennehy Weller & Co, what drives share prices is people buying stock. "This requires confidence. Remember that since December 1999 improving profits have not driven share prices up, rather the market has de-rated, and ignored improving profits.

"Perhaps the key in the Motley Fool story is the word "…eventually" – that the quality of company earnings will eventually see share prices improve. One piece of research noted that it can take value stocks 13 years on average just to revert to mean!"

If the FTSE plummets next year, then company earnings, after all, are likely to stay low for some time.

Also consider the psychology behind buying shares

Behavioural science argues that people are not nearly as rational as traditional finance theory makes out, so share prices are therefore not driven by rational decision-making. Emotions and biases also drive share prices.

Investopedia says: "If individuals and institutions are upbeat about the future prospects for the economy and the markets, they will often purchase stock and drive prices up. On the flip side, if individuals and institutions are bearish about the future, they may sell some of their stock holdings. This can create a self fulfilling prophecy – in the markets, wide-scale pessimism can drive down stock prices.

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