Here's why stock price of a company goes up
Do you know why off late stock prices of certain companies have shot up by more than 25 per cent in three weeks?
It is very difficult for many people to understand why a particular share jumps up say 25 per cent in 3 weeks.
Their immediate question is 'What changed in the company in 3 weeks to justify such a rise?'
Have you ever asked yourself this question? Well the answer is not easy to give. Also I am convinced that I CANNOT teach equity and valuation, I can only keep giving tons of examples. It is your job to read, assimilate, understand the CONTRADICTIONS, make an essence and drink it.
When the economy is down, companies cut down on some essential expenses, give up on margin and flog the existing assets. As the market starts to go up, the following things happen:
1. Company is more comfortable in increasing prices
2. Dealers are more willing to store the products
3. Sales beyond BREAKEVEN is sheer profit. Look at companies like Ashok Leyland and Tata Motors (TM is no longer an India centric company – 78 per cent of its revenue will come from JLR). Suddenly when volumes go up, the profits double or even triple.
4. For the more serious student, go and see what happens to the operating leverage.
Does all this happen in 2 weeks? or 3 weeks? Well no.
However the numbers start leaking – from Excise authorities, advance tax figures, bankers, auditors.
So there is some buying from people normally close to the management. I know one very big auto component manufacturer who tracks this very well. He knows the 3 month plan because he is a supplier, and when they ask him to ramp up production…he is good at picking up signals.
While all this is happening, if your interest rates come down (or you use the new cash flow to reduce debt) – you are now getting a greater impact of the Operating leverage..so for every increase in sales, the profits jump dramatically.
Exactly why my friend who invested in Ashok Leyland / Tata Motors DVR and Eid Parry is cheering... he invested about a month ago. :)
Image: A bronze sculpture of a bull is seen on the premises of the Bombay Stock Exchange.
Photographs: Arko Datta/Reuters