At the end of our last Investing Basics for Savvy Women episode we asked a question: “Do you always make money in owning a stock of a single company?”
The answer is emphatically no. Any company can fail. Any company can lose market share…sales…and profitability, all of which could easily lead to a lower stock price. If a company’s profit goes down year after year, the chances are that the demand for the company’s stock will decrease, as will the price of the stock. After all, would you pay more for a company whose profits are consistently decreasing? Probably not. So a likely outcome in this case is that the supply of the stock, or those people willing to sell their shares or stock, would be greater than the demand, or those wanting to buy the stock. More people wanting to sell than wanting to buy would cause the price to go down.
Let’s take a look at a great example of supply and demand in action as this illustrates what causes stock prices to go up or down.
Some of you might remember when the Cabbage Patch Kids Dolls were all the rage in the 1980s. I mean the Cabbage Patch Dolls were off the charts crazy hot. They were the hottest toys on the market and every parent wanted to buy one for their kids. At the height of the craze, around 1985, people were willing to pay, and do, just about anything to get their hands on a Cabbage Patch Doll, especially as a Christmas gift. The problem was that Coleco, the company that was making the dolls, just couldn’t make the dolls fast enough. So the supply of dolls could not keep up with the demand for them.
As a matter of fact, the demand was so high that profiteers and collectors grabbed the dolls off store shelves and tried to resell them through newspaper and magazine ads at outrageously high prices. Remember, high demand and low supply. This supply/demand imbalance literally caused fights to erupt in stores as frantic parents fought each other to secure one of the prized Cabbage Patch Kids Dolls for their children. As a matter of fact there literally were riots that broke out at some of the stores that got shipments of Cabbage Patch Dolls.
There’s a really good recounting of this story on a site called Mortal Journey, we have included the link below: http://www.mortaljourney.com/2011/01/1980-trends/cabbage-patch-kids-dolls.
According to Mortal Journey, by 1985, Coleco, the manufacturer of the dolls, had sales of over $600 million, but by the very next year the craze was already starting to fade and sales fell to $250 million. The scalpers were caught with large amounts of dolls that nobody wanted to buy while Coleco tried to bring the demand back by remarketing them with gimmicks such as talking dolls and dolls that played kazoos.
Eventually, the craze died and Coleco went out of business. So at the height of the craze, with demand surging and a limited supply of the dolls, the price to own a doll was going through the roof. Just a couple of years later, no one was buying the dolls and the price cratered. That’s supply and demand 101 folks.
So let’s relate this to how a stock price moves up and down. If you could have bought stock in Coleco before the craze hit, you could have made a lot of money as profits soared and a theoretical price for the stock would have gone soaring too. But if you bought into the company at the height of the craze in 1985, the demand for your shares of stock would have waned dramatically over the next couple of years and by 1987 you might have lost most everything you invested.
Now there are other factors in what might cause a company’s stock price to decline. It’s possible that some unforeseen event happens like what happened to Chipotle Mexican Grill in 2015 as food poisoning in a couple of their restaurants sickened many people. As you might imagine, the stock price fell fast and hard.
Then there are some companies in which you can buy stock that are speculative to begin with such as a start up technology or biotech company. These companies might not have any profits currently because their money is going into research and development. They might have start up money on which the company has to survive until it can become profitable…which in many cases is never!
So why would someone invest and buy shares of such a company? It’s because hope springs eternal. Let’s say a biotech company is working on a cure for cancer and the testing along the way shows positive results, there are some people who might take a chance that if the cancer cure is found, then the price of the stock will go up rapidly, so it might be worth buying it today. In many cases, the cure is never found and the company files for bankruptcy.
This is just a partial list of reasons that stock prices could fall. There are many pitfalls to what could happen to any ONE company. That’s the reason that most stock investors buy a multitude of stocks when they invest.
We’ll talk about that in our next “Investing Basics for Savvy Women” video when we cover the topic of mutual funds.
Until then, to all our female viewers…Savvy Up!!
If you have any questions or would like to schedule a discovery session you can reach us at
760-692-5700
#SavvyUp