What gives a stock its value?

When you look at a stock chart, you see a jagged line moving up and down, sometimes violently. On one day, a company like Apple or Tesla might be “worth” 5% more than it was yesterday. On another day, it might plunge 10%.

Did the company actually sell 10% fewer iPhones overnight? Did their factories disappear? Probably not.

This leads to the most fundamental question in the world of finance: What actually gives a stock its value?

Is it just a casino where prices are random numbers? Or is there a scientific formula behind the madness? The answer lies somewhere in the middle. The price of a stock is a tug-of-war between cold, hard math and human emotion.

In this guide, we will peel back the layers of the stock market. We will move beyond the ticker tape to understand the intrinsic factors (earnings, assets, dividends) and the extrinsic factors (economy, psychology) that determine how much money comes out of your pocket to buy a share.

1. The Foundation: It’s All About Earnings

At its simplest level, a stock is a piece of paper (or digital code) that proves you own a fraction of a business. Therefore, the value of the stock should logically track the success of the business.

The primary driver of stock value over the long term is Earnings (Profit).

The Lemonade Stand Analogy

Imagine your neighbor runs a lemonade stand.

• Scenario A: The stand makes $100 a year in pure profit.

• Scenario B: The stand makes $10,000 a year in pure profit.

Obviously, you would pay much more to buy ownership in the stand from Scenario B.

In the stock market, this is measured by Earnings Per Share (EPS). If a company makes a lot of money, they can do two things:

1. Reinvest it: Build more factories to make even more money later.

2. Pay you: Send you a check (dividend).

Both options increase the value of the share. If a company stops making money, or if their profits shrink, the stock price will eventually crash, no matter how popular the brand is.

2. The P/E Ratio: How Investors Measure “Cheap” vs. “Expensive”

Knowing the earnings isn’t enough. You have to know how much you are paying for those earnings. This introduces the most famous metric in investing: the Price-to-Earnings Ratio (P/E).

The P/E ratio answers the question: “How many dollars do I have to pay today to get $1 of the company’s earnings?”

• Stock Price: $100

• Earnings Per Share: $5

• P/E Ratio: 20 ($100 / $5)

What Does This Tell Us About Value?

• A Low P/E (e.g., 10): The market thinks the company is risky or has stopped growing. It is “cheap.”

• A High P/E (e.g., 50): The market expects the company to explode in growth. Investors are willing to pay a premium now for profits that will arrive years later.

Value is relative. A tech company growing at 50% a year might be “cheap” at a 40 P/E, while a bank growing at 2% a year might be “expensive” at a 15 P/E.

3. Future Expectations: The Time Machine Effect

This is where beginners get confused. They see a company announce record profits, yet the stock price drops. Why?

The stock market does not care about the past. It only cares about the future.

Stock prices are essentially a “discounting mechanism.” The current price represents what investors believe the company will earn in the future, adjusted for the risk of waiting.

The “Priced In” Phenomenon

If everyone expects a company to have a great quarter, the stock price rises before the report comes out.

• The Expectation: Analysts predict $1 billion in profit.

• The Reality: The company announces $1 billion in profit.

• The Reaction: The stock price might stay flat or drop.

Why? Because the good news was already “priced in.” For a stock to gain value, it must not just do well; it must exceed expectations. It must surprise the market.

4. Assets and Book Value: What Do They Own?

Let’s imagine a worst-case scenario: The company goes bankrupt tomorrow. Does the stock have value?

This brings us to Book Value. This is the value of the company’s tangible assets minus its liabilities.

• Factories

• Real Estate

• Inventory (unsold goods)

• Cash in the bank

• Patents

If you subtract all the debts the company owes, what is left is the Book Value.

For industrial companies (like car manufacturers or steel mills), this physical value is very important. If the stock price drops below the Book Value, investors might rush in to buy it because they are effectively buying dollar bills for 80 cents. This is the core of “Value Investing.”

5. The Economic Moat: The Value of Unfair Advantages

Why is Coca-Cola worth more than a generic soda company, even if the generic company has similar factories?

It’s called the Intangible Value, or as Warren Buffett calls it, the “Economic Moat.”

A stock commands a higher value if it has a protective barrier that prevents competitors from stealing its customers.

1. Brand Power: People trust the name (e.g., Apple, Nike).

2. Network Effect: The service gets better if more people use it (e.g., Visa, Meta).

3. High Switching Costs: It’s too hard to leave (e.g., Microsoft Office).

These intangibles don’t show up clearly on a balance sheet, but they are a massive component of a stock’s market capitalization. They provide the “certainty” of future earnings.

6. Supply and Demand: The Short-Term Voting Machine

In the long run, earnings determine value. But in the short run, value is determined by Supply and Demand.

The stock market is an auction.

• If more people want to buy (Demand) than sell (Supply), the price goes up.

• If more people want to sell than buy, the price goes down.

Share Buybacks: Manipulating Supply

Companies can artificially increase the value of their stock by reducing the supply. This is called a Stock Buyback.

The company uses its own cash to buy shares off the market and destroys them.

• Result: The pizza is cut into fewer slices. Your slice (your share) becomes a larger percentage of the company. Even if total profit stays the same, the Earnings Per Share goes up, usually driving the price higher.

7. The Gravity of Finance: Interest Rates and The Fed

Here is a secret that dictates global markets: Stock values are inversely related to Interest Rates.

Think of interest rates as “financial gravity.”

• Low Interest Rates: Gravity is low. Money is cheap to borrow. Savings accounts pay 0%. Investors are forced to buy stocks to get a return. Stock valuations float higher (P/E expansion).

• High Interest Rates: Gravity increases. Borrowing becomes expensive for companies (hurting profits). But more importantly, “risk-free” government bonds start paying 5% or 6%.

The Competition for Capital

If you can get a guaranteed 5% return from a US Treasury Bond, why would you risk your money in the stock market for a potential 7% return? You wouldn’t.

As interest rates rise, investors pull money out of stocks and put it into bonds. This selling pressure lowers the value of stocks. This is why when the Federal Reserve speaks, the stock market holds its breath.

8. Dividends: The Bird in the Hand

For many investors, value comes from cash flow right now, not a promise of growth later.

Dividends are cash payments made directly to shareholders, usually quarterly.

• The Yield: If a stock costs $100 and pays $4 a year, it has a 4% Dividend Yield.

For retirees and pension funds, a reliable dividend gives a stock immense value. In times of market volatility, “Dividend Aristocrats” (companies that have increased payouts for 25+ years) often hold their value better than high-flying tech stocks because the investors refuse to sell and lose that income stream.

9. Sentiment and Hype: The Irrational Factor

We cannot ignore the human element. Sometimes, value is driven purely by Hype and FOMO (Fear Of Missing Out).

This creates a separation between Price and Value.

• The Dotcom Bubble (2000): Companies with zero profit were valued at billions because they had “.com” in their name.

• The Meme Stock Craze (2021): Companies like GameStop skyrocketed not because the business improved, but because an internet community decided to buy it en masse.

While sentiment can drive prices up temporarily, gravity eventually takes over. As the father of value investing, Benjamin Graham, famously said:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

10. Liquidity: The Ease of Exit

Finally, a hidden factor of value is Liquidity.

How easy is it to sell the stock?

• High Liquidity: You can sell $1 million of Apple stock in one second without affecting the price.

• Low Liquidity: A small “Penny Stock” might have no buyers. If you try to sell, you crash the price.

Large institutional investors (who move the market) place a premium value on liquid stocks because they need to know they can exit the position if things go wrong. Illiquid stocks often trade at a “discount” because of this risk.

The Mosaic of Value

So, what gives a stock value? It is never just one thing.

It is a complex recipe involving:

1. Current Profits: How much cash the machine prints today.

2. Future Growth: How much cash it will print tomorrow.

3. Assets: What the machine is made of.

4. Interest Rates: The cost of money in the broader economy.

5. Psychology: How much people like the story the company is telling.

As an investor, your goal is to find situations where the Market Price is lower than the Intrinsic Value. When you find a company with strong earnings, a protective moat, and a bright future selling for a price that ignores those facts—that is when you have found true value.