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# Why do Stock Prices Move?

The first sign that the revised information has become public may be a sharp drop in the stock's price. In fact, the stock might gap up or down, opening 10- to 20 percent higher or lower than it closed the day before. But it may take several weeks or months for the full effect of the change in market perception to be reflected in the price of the stock. One reason for this delay is that institutional investors take a long time to build (or sell off) a position in a stock because of the size of their holdings. So even though the wave of knowledge began with that first nugget of information, the change in market perception won't be complete until the institutions have opened or closed their positions.

Investor confidence is the other crucial factor in the structure of stock valuation. To maintain a stock's valuation, confidence that future earnings will actually occur is just as important as the market's perception that the EPS growth rate will be high. It should be obvious that an investor would be willing to pay more for a stock that he or she is confident will continue to grow at a rate of 20 percent than one in which such certainty didn't exist.

Confidence is based on a company's past performance, and it usually doesn't come or go quickly. Once a company has a history of consistently meeting or exceeding its earnings projections quarter after quarter, investors become confident that it will continue to do so. For instance, if a company has grown at a rate of 20 percent per year for a number of years, it becomes easy to believe that it'll continue to do so if that's what the analysts are projecting. A strong earnings history provides confidence in the projected future earnings. This confidence in the company's future earning ability is reflected in a higher P/E; in other words, a higher stock price compared with current earnings.

The combination of market perception and investor confidence in the future earnings growth of a company is what drives stock prices and thus P/E ratios. Changes in either or both create a change in the price of the company's stock, whether up or down.

For a discussion of some of the events that can influence investor outlooks, please read the article How Events affect Perception and Investor Confidence.

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