By Bob Shapiro
Stock prices change minute to minute based on investor perceptions and emotion. Investors compare the current price with current – and expected – earnings.
Over the longer term, it is earnings which will determine the trend of a stock’s price history. You would (correctly) expect that if Company A’s earnings rose by 25% a year for 10 years, while earnings for Company B fell by 25% a year, that the price of Company A stock would have gone up dramatically, while the stock of Company B would have fallen drastically.
One metric that investors use to compare the stock of different businesses is the PE Ratio – a simple division of the Price by the Earnings per Share (usually for the last 12 months). As optimistic investors put more money into a particular stock, the price goes up, and with it the PE Ratio also goes up.
Optimism implies that investors expect the future prospects for a business to be good. If business really is going to be good, you would expect the managers to try to put more capital to work. The business can get this capital in several ways.