What causes share price of a business to decline is business deterioration. Mainly, stocks decline as the result of poor earnings, poor balance sheet and the share price being too high for the value (Net Cash Flow).
Prices in any market are determined by the laws of supply and demand, market momentum, customers’ mood and the amount of speculation. Therefore, the share price of the company stock will mainly decrease under the abovementioned conditions.
1. POOR DEMAND
Laws of supply and demand apply here.Business performance deteriorates and investors choose to invest in better businesses. There are several signs which indicate that the business is performing worse than before. It has worsening:
- Worsening Profit and Loss Account (P&L Account). Sales Revenue is declining. Costs are rising, Interest payments are rising, TAX payments are high. And profits are declining or the business is making a loss.
- Weak Balance Sheet. When cash evaporates, debt grows, inventories increase, debtors increase and Liabilities equal to 100% of Equity (Short-term Liabilities + Long-term Liabilities – Cash = 100%) these are the indicators of a worsening Balance Sheet.
- Troubles with Cash Flow. Businesses typically have problems with liquidity with Cash Inflows are declining, Cash Outflows are increasing and Net Cash Flow is declining or negative.
2. DOWNWARD MARKET MOMENTUM
Market momentum applies here. This means when the overall market sentiment supports selling with following market trends. Negative momentum indicates a bearish trend pushing the price downward following others (herding strategy).
3. PESSIMISTIC INVESTORS
Investors’ mood applies here. In general, prices positively correlate with investor mood with higher asset prices linked with better mood. A negative mood state will make investors more pessimistic about the future, therefore less willing to make risky investment decisions, or pay higher prices. Numerous events can impact social mood such as war, natural disasters, health epidemic, the weather, results of important sporting events, etc.
Mood is composed of two dimensions: pleasantness and activation. Together, these two dimensions form four quadrants of mood: high activation and pleasantness (e.g. enthusiasm), low activation and pleasantness (e.g. calmness), low activation and unpleasantness (e.g. depression), and high activation and unpleasantness (e.g. anxiety).
4. NEGATIVE SPECULATION
The amount of speculation applies here. All the speculation that is happening against the company. Financial speculation of stocks that can drive stock price down includes selling and short-selling. With sellers of stock, they will sell, if they speculate that the market will decrease in value or if a company’s stock price will decline.
5. Other external factors beyond the business’s control
There are many reasons why stocks might decline. Some of the most common reasons include:
- Economic downturn. When the economy is doing poorly, businesses are less likely to be profitable, which can lead to a decline in stock prices.
- Negative news. If there is negative news about a company or the economy, it can lead to a decline in stock prices. For example, if a company reports poor earnings or there is a terrorist attack, it can cause stock prices to decline.
- Changes in interest rates. When interest rates rise, it can make stocks less attractive to investors because they are more expensive. This can lead to a decline in stock prices.
- Political uncertainty. If there is political uncertainty, such as a change in government or a war, it can lead to a decline in stock prices.
- Technical factors. Sometimes, stocks decline for technical reasons, such as a large sell-off by investors. This can happen when there is a lot of selling pressure in the market or when a stock breaks below a key support level.
It is important to note that there is no guarantee that stocks will always decline. The stock market is volatile and can go up and down for many reasons. However, by understanding the factors that can affect stock prices, investors can make informed decisions about which stocks to invest in.
