Question

are share price always reflective of the underlying performance of a company? provide arguments for and against. at the aggregate level, does the stock market always reflect the underlying performance of all firms? provide examples if possible.

Answer 1

Before answering the question please note that how prices of a company's shares are determined in the stock market. It is based of the demand and supply forces of the market. If the market demand of the share are higher then the supply of the shares the market share price will rise or vice versa.

Now, the question arises what drives the market demand of a share.It is the investor's belief that the company will do good in future as such the overall financial health of the company is satisfactoryy.

If investors beliefs are overturned or investor believes that share is not performing at par it will sell the share leading to supply in the market.

No, the share price are not always reflective of the underlying performance of a company and as such stock market does not always reflect the underlying performance of all the firms.

Finacial health of the company is one of the factors that increase the performance of the the company but there are various other factors that drives the performances of the share as well that has nothing to do with company such as :-

Factors Against are :-

1) Political Factors - Political stability will always increase the prices of the indices and the market share price in an overall level as it brings a sense of security and stability to the investors. If goverment makes positive policies which are favorable from the point of view of investors the prices will increase

2) Economy as a whole also affect the stock price as if the country is in slowdown the investors will not be motivated to invest in the companies.

Factors in support are :-

1) Analyst viewpoints are very important and factor in determining the price. If the analyst beleives that due to some decision that the company is going to take for eg new products, mergers and acquistion  that will positively impact the finacial heath of the company, the stock price will increase or vice versa hence it is performace based.

2) Dividend - If a company declares heavy dividend it will show company has strong financial position and investors will be motivated to invest.

Hence, we conclude the stock prices are based on various factors and one of the factor is performance of the company,