Readers sometimes ask me questions they think are embarrassing. No, not those kinds of questions, but ones about money. They don't seem embarrassing to me -- I know most people never learned this stuff in school.
For example, someone will ask, "Who sets the prices of stocks each day?" Or "Why does a stock's value go up and down so often?"
The answer can be summed up nicely in a Latin quotation from the folks at ifa.com: "Res tantum valet quantum vendi potest." For the Latin-challenged, that means: "A thing is worth only what someone else will pay for it."
In other words, if a stock is seen as valuable, people will be willing to pay a lot for a share of it, and thus its price will be high. And vice versa. The stock market really works like an auction -- imagine one with baseball cards. A Mickey Mantle rookie card might be seen as very valuable, partly due to its scarcity. If I'm pretty sure I can sell it for around $100,000, I'd be willing to buy it for around $100,000 or less. That's its perceived value. But if suddenly several thousand more of those cards are discovered, the value will likely diminish -- just as suddenly.
The folks at ifa.com used the example of Bear Stearns (NYSE:BSC) stock, noting that on Friday, March 14, the share price was $30, and on Monday morning, March 17, it was suddenly valued at $3.17 per share. Over the weekend, after learning about its subprime lending mess, investors suddenly thought very differently about the company. It wasn't worth $0, though, because at some price (which happened to be $3.17 that morning) someone found it worth buying.
You can find countless examples of this every day. A few weeks ago, for instance, shares of Sun Hydraulics (NASDAQ:SNHY) rose 12% because the company had just reported strong earnings, with hints of more growth to come. Investors suddenly saw the company as worth more, and were willing to pay more per share to own it. Meanwhile, the same day, Atlantic Tele-Network (NASDAQ:ATNI) shares dropped 16% because its just-reported gains in revenue and net income were still disappointing to investors.
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