The stock market includes thousands of companies in scores of industries and groupings. While they may go up and down for any reason any day, there are underlying patterns behind price movement.
This article reviews an earlier series on Market Insights explaining seven basic catalysts in the stock market. These go deeper than the fundamentals of individual company or sector, giving investors a structure for understanding news and the opinions of Wall Street.
Each of the narratives can apply to any company, although they may be expressed differently for different sectors. It’s also common for multiple catalysts to be at work at any given time.
The final thing to remember is that the stock market is forward-looking, pricing in news before it happens. As a result, investors often act in expectation of these catalysts.
Volumes and Margins
Volumes are probably the most straightforward and common catalyst. This simply means the amount of business being done. They vary widely based on the good or service in question. Volumes may be expressed in units sold, seat miles flown, monthly average users or subscriptions. Volumes are a key factor determining revenue. Pricing, the other key factor, falls under margins — our next catalyst.
Margins represent how much profit companies earn on their business. They can be improved by raising prices and/or lowering costs. While margins are separate from other items on this list, they can be strongly impacted by other catalysts. For example, increased volumes can widen margins by spreading out fixed costs. (This is “operating leverage.”) Business transformation (see below), like changing products, can also result in higher profitability.
What Are Strategic Actions?
Strategic actions involve changing the structure or financial policies of the corporation. These can include spinoffs, which is when management splits different businesses into different companies. Johnson & Johnson (JNJ) is currently in the process of such a transaction. This year also featured similar moves with Dell (DELL) spinning of Vmware (VMW) and L Brands turning into Bath & Body Works (BBWI) and Victoria’s Secret (VSCO).
Strategic actions also include mergers, stock splits, special dividends and stock buybacks. Remember that they don’t change the underlying business. They simply change the box housing the business.
Macro trends apply to forces outside a company’s control, like the economy. Investors may buy cyclical stocks like financials and retailers at the end of a recession, and sell them when they think a slowdown is coming. Interest rates can also influence valuations, while commodity prices impact producer companies.
Investor rotation is closely associated with macro trends, but can be longer lasting. It often occurs around calendar periods like quarters and years as large money managers allocate based on wider themes. This has recently entailed a focus on innovative growth stocks, although that may be changing as the Federal Reserve tightens monetary policy.
Business Models Matter
Business transformation, unlike strategic actions, change the underlying business. This usually entails new products or new customers. A recent example is Ford Motor’s (F) shift to electric vehicles. It can also entail and new revenue models, which has been common in technology as software companies push customers into subscription models. (These reduce marketing cost and attrition, boosting margins over time.)
Credit applies to the balance sheet. While this is the least common catalyst, it can play a major role when it occurs. Credit trends include the impact of debt and asset values. For example, Avis Budget’s (CAR) dramatic rally this year resulted from an unexpected surge in the price of used cars (a balance-sheet asset). The 2008 financial crisis was an even bigger example of credit’s impact on the market.
Refinancing liabilities is another part of the story: Can a company keep rolling its debt? Are interest costs rising or falling? Should management raise equity capital (sell shares) to pay creditors? Such moves, which touch upon strategic actions, can also have a big impact on stock prices.
