I don’t understand why (non-dividend paying) stocks increase in price when a company is successful; is it just because everyone expects that everyone else will find it more valuable because the company is doing better? Is the link between this type of stock and the company really just psychological? If investors are getting something other than dividends or just “ownership,” from buying this type of stock, what is it?
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1$\begingroup$ this might technically be still on topic here but better fit for quantitative finance stack exchange that focuses on issues like stock valuation rather than economics in general. From economic perspective I don't know of any stock valuation model that would not incorporate some parameters like expected profitability of company and so on. The key word here is expected - past performance is water under bridge what matters is future. People can have different expectations what will happen in future even if they are completely rational and calculating (which does not mean they always are) $\endgroup$– 1muflon1 ♦Commented Feb 8, 2021 at 12:35
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2 Answers
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Even if a company pays no dividends, its price will usually reflect its "fundamentals" or "how well it's doing". This is because:
If the price is too low (relative to any metric, be it earnings, growth, etc.), then anyone can profitably launch a takeover/acquisition bid.
Example. A company has 1B shares each priced at \$1 (so market cap is \$1B), pays no dividends, and earns \$100B (profits) per year. Then one could buy up all 1B shares for \$1B, own the company entirely, and enjoy \$99B in profits in just the first year alone.
(Second and third paragraphs are identical to another answer I gave.)
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Short answer is market values change when perceptions of the market valuation of the stock changes between at least one buyer and one seller in the last trade of shares.
Long analysis first watch this video by Aswath Damodaran On The ‘Dark Side Of Valuation’:
https://www.youtube.com/watch?v=3DtpkMOjH7s
Then read his 50 page paper The Dark Side of Valuation: Firms with no Earnings, no History and no ComparablesCan Amazon.com be valued? - March 2000
http://people.stern.nyu.edu/adamodar/pdfiles/papers/HighGrow.pdf
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$\begingroup$ All prices expressions of social psychology. I learned about valuation in a law school course called Remedies where a dispute arises, some assets have market prices or other easy to set valuations, and other assets require a battle of experts who have incentives to high-ball and/or low-ball valuations depending on who is paying their fees. Suppose a start-up fails to reach break-even cash flow and raises more cash to purchase assets to grow sales. The new debt or equity investors can value existing shares at a premium or discount compared to original cost basis. Discount called a "cram down". $\endgroup$ Commented Feb 9, 2021 at 14:42