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I have heard that people say the greater earning means greater intrinsic value of the company. Then, the stock price is largely based on the intrinsic value. So increasing intrinsic value due to increasing earning will lead to increasing stock price.

What is the relationship between the earnings of a company and its stock price?

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In general over the longer term this is true, as a company whom continuously increases earnings year after year will generally continue to increase its share price year after year.

However, many times when a company announces increased earning and profits, the share price can actually go down in the short term. This can be due to the market, for example, expecting a 20% increase but the company only announcing a 10% increase. So the price can initially go down. The market could already have priced in a higher increase in the lead up to the announcement, and when the announcement is made it actually disapoints the market, so the share price can go down instead of up.

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  • ok, so what's the mechanism behind this long term process ? I mean why higher earning increases the demand for this stock; thus, increasing its price. I'm just very confused on this point. – Chenxiong Yi Feb 16 '15 at 21:24
  • @ChenxiongYi, If you were to buy a business off someone else would you pay more for a business not making any profits or for a business making alot of profits and increasing those profits year after year? – user9822 Feb 16 '15 at 22:00
  • yes, intuitively, it should be the one that has lots of profit. But how can buyer benefit from the profit ? do they get more dividend or make money from appreciation ? – Chenxiong Yi Feb 16 '15 at 22:03
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    Yes, and yes, potentially. Companies manage their stock price to be high enough to discourage takeover (repurchasing when that makes sense), so price longterm tends to track that risk, which tracks their value. Dividends theoretically should track profit, since they're you portion of net profit after reinvestment... but the balance between dividends and reinvesting can be adjusted depending on the company's needs and whether the stockholders are demanding more dividends or higher stock price. – keshlam Feb 16 '15 at 23:45
  • @ChenxiongYi, well that is what drives the demand for stocks with increasing profits, more people would prefer to buy stocks in company's with increasing profits rather than ones with decreasing profits. These increasing profits can be used to grow the company further or to return to shareholders as higher dividends, or a combination of the two. If you buy shares in a company which increases profits year after year for 10 years and you sell after 10 years, you will most probaly have sold for higher than you bought at and probably would have received increasing dividens over the 10 years. – user9822 Feb 17 '15 at 5:42
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I have heard that people say the greater earning means greater intrinsic value of the company. Then, the stock price is largely based on the intrinsic value. So increasing intrinsic value due to increasing earning will lead to increasing stock price. Does this make sense ?

Yes though it may be worth dissecting portions here. As a company generates earnings, it has various choices for what it can do with that money. It can distribute some to shareholders in the form of dividends or re-invest to generate more earnings. What you're discussing in the first part is those earnings that could be used to increase the perceived value of the company. However, there can be more than a few interpretations of how to compute a company's intrinsic value and this is how one can have opinions ranging from companies being overvalued to undervalued overall.

Of Mines, Forests, and Impatience would be an article giving examples that make things a bit more complex. Consider how would you evaluate a mine, a forest or a farm where each gives a different structure to the cash flow? This could be useful in running the numbers here.

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You would think that share prices is just a reflection of how well the company is doing but that is not always the case. Sometimes it reflects the investor confidence in the company more than the mere performance.

So for instance if some oil company causes some natural disaster by letting one of there oil tankers crash into a coral reef then investor confidence my take a big hit and share prices my fall even if the bottom line of the company was not all that effected.

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