Question

In: Finance

The price of a stock is directly related to the expected future price and earnings. Select...

The price of a stock is directly related to the expected future price and earnings. Select one: True False

Solutions

Expert Solution

False.

The price of a stock is not directly related to the expected future price and earnings. It is related to a lot of different things.
Let's understand in detail.

No-one can predict the future. Thus expected future price and earnings are statistics which are driven by certain variables and assumptions carried out by Financial Analysts. They design financial models which show what the financial future of the company would look like. This is done by doing a lot of research on the past trend of the earnings and future management outlook. Also industry dynamics, order book of the company, macroeconomic dynamics, industry demand and supply are taken into consideration.

The stock price is said to price in all the available information. Thus when these future earnings are broadcasted on the live media portals, there is a temporary movement in the stock price due to the expected earnings potential and figures, However this is short-lived. The actual stock price of the company is determined by the true underlying value of the company which is called as the Intrinsic Value of the stock. It should be noted that these future forecast of price and earnings are ultimately forecasts and no-one knows what the actual figures are likely to be. Thus it can be said that which there can be a temporary movement in the stock price when the expected future price and earnings are shown on the live online portals like Bloomberg Terminal and Thomson Reuters, it is a fact that ultimately the stock price will revert to the price which depicts the true earning potential and underlying value of the company.

Also a lot of the news flow impacts the stock price in the short term. However in the long term the stock price will always revert the the actual Intrinsic value which is defined by the inherent fundamentals of the company and the true earning potential of the company.



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