These days, it seems like every minute brings a new headline: inflation surprises, interest rate changes, a central banker’s hint, new tariff signaling, or a CEO’s offhand tweet. It seems the market jumps, tumbles, and pivots on whatever dominates the news cycle.
It’s no wonder so many investors feel overwhelmed and wonder: what’s really going on with the stock market?
In today’s post, we’ll focus on the two simple forces that actually drive stock prices — so you can feel more confident about what matters and what doesn’t.
When you strip away the noise of financial news, analyst opinions, and market hype, the price of a stock is ultimately driven by just two factors:
- How much money the company earns (or is expected to earn)
- How much investors are willing to pay for those earnings
Everything else — economic data, interest rates, CEO tweets — feeds into these two factors. Understanding them can transform the way you approach investing.
Let’s get started.
Factor 1: The Company’s Earnings
Think of a stock as owning a slice of a pizza shop. The value of your slice depends on how much pizza the shop sells, how profitable it is, and whether it’s growing over time.
Earnings are the company’s profit — the money left over after all the bills are paid. Here’s what can push those earnings up or down:
- Sales Growth: Are customers buying more? Are prices going up?
- Costs: Can the company keep costs under control so more sales turn into profit?
- Competitive Advantage: Do they have something special (brand, patents, network effect) that keeps competitors from eating their lunch?
- Economic Backdrop: A booming economy lifts most businesses. A recession does the opposite.
- Management Moves: Good (or bad) decisions on spending, investing, or buying other companies all matter.
The higher and more reliable the earnings, the more your slice of the “pizza shop” is worth.
Factor 2: What People Are Willing to Pay
This is where psychology comes in. Even if two companies make the same profit, investors might value them very differently based on their future expectations.
Enter the price-to-earnings (P/E) ratio — it tells you how much investors are paying for $1 of a company’s earnings.
Key drivers of P/E ratios:
- Growth Expectations: Fast-growing companies command higher multiples.
- Interest Rates: Lower rates push valuations higher, and vice versa.
- Risk Appetite: Fear drives P/Es lower; optimism pushes them up.
- Market Trends: Some sectors (like tech) trade at higher P/Es simply because investors expect more innovation.
The Current Macro Picture — and What It Means
Right now, economic indicators are sending a mixed but fascinating message:
- Interest Rates: Despite the recent interest rate cut, the Fed has kept rates higher for longer to combat inflation. This often pressures P/E ratios, since investors can earn decent yields in safer bonds.
- Inflation: While cooling, inflation is still above target in some areas. Companies with pricing power, those who can raise prices without losing many customers, may keep growing earnings, but margin pressure is real for others.
- Consumer Spending: Still strong in many sectors, though we’re starting to see cracks in discretionary spending — this could weigh on earnings growth.
- Corporate Guidance: Many firms are cautiously optimistic, but forward guidance suggests slower earnings growth compared to 2021–22’s post-pandemic surge.
- Market Sentiment: Despite macro headwinds, investors are still paying up for growth — particularly in AI-related and tech names — pushing P/E ratios for those sectors well above historical averages.
Putting It Together — A Real-World View
- Earnings Per Share (EPS): Still trending up, though growth is slowing in some sectors.
- P/E Ratios: Cooling off from pandemic peaks but still elevated versus history as you can see in the chart above.
This means earnings are doing their part, but valuations are a bit stretched. Future returns may depend more on whether companies can keep delivering growth that justifies those higher prices.
The Bottom Line — and Your Next Step
At the end of the day, stock prices always come down to two questions:
- How strong are the company’s earnings?
- Are you paying a fair price for them, given today’s economy?
With rates still relatively high and growth a bit uneven, now is a great time to take a fresh look at your portfolio and make sure you’re positioned for where the market is headed — not just where it’s been.
Interested in a second opinion? The team at Master’s would welcome the opportunity to review your investment portfolio and help you navigate today’s market with confidence. Reach out today to start a conversation.
