FAIR WARNING: Do not read this piece late at night unless you are trying to go to sleep and pills just aren't working. This one gets more technical than most of the columns but if you stay with it and work through the principle, you'll understand part of why stocks are priced where they are and why there are buyers and sellers at the same price.
One place to start for determining a price is adding up all the assets of a company (what it owns), subtract the liabilities (what the company owes), and say what ever is left over is the value of the company. Then divide that by the number of shares the company has outstanding to determine the price of the stock. That would be OK if you wanted to find the price of a stock just for that one day, the one day you did the calculation. You would have, in fact, determined the book value of the company by using that method. Some investors still focus on that valuation and try to buy stocks below their book value. The famous Benjamin Graham, the father of fundamental analysis of stocks, used to buy stocks that were selling at 50% of the their book value. So you'd be in good company if you stuck to that program.
But that isn't the way most investors view a company. In fact, one of the basics of stock valuation, accepted as the standard, is something called the present value of discounted future earnings. Since a company is an ongoing concern, meaning it will continue to crank out widgets and profits into the future, the real question for investors is: how much is the company worth based on its future earnings capabilities? Or, how much are those future earnings worth in today's dollars? Figure that out, and you get to a price for a stock. Of course, the assumption in all this is that the company is actually earning money or will. If a company doesn't earn money, you can't do any calculating because the company won't be here after a while.
Here's how it all works. First the concept of present value of discounted future earnings: this is the same idea behind the present value of a future dollar. If you know you will receive one dollar a year from now, what would you pay for it? You wouldn't pay a dollar because you can take a dollar now, invest it, and whatever interest rate you receive would be the dividend on your dollar. Let's say that's 5%. So if you have a choice between taking a dollar today and investing it for one year, or buying a dollar today for delivery to you a year from now at some price, you would be willing to pay about 5% less ($.95) for the dollar because that way you are getting a 5% return on your investment (actually a little more because you are getting 5 cents on a 95 cent investment, but let's just round it off to a 5% return). If you decided to invest your dollar today in an interest bearing account, and you received a 5% return, then you'd have earned the same amount from that investment as from buying the dollar at a discount. You wouldn't care which investment you made because you'd earn the same return on either one.
If you look at that paragraph again, here's what we're doing: the present value of a future dollar, when interest rates are at 5%, is 95 cents. If you think about that in terms of a company's earnings, you can see that the future earnings of the company, over some time period, discounted back to the present value of those earnings, will be the value of the stock price. The reason for that is because the earnings are what go into the equity of the company after all the bills have been paid. The equity is what the shareholders own or have a claim on. So when the earnings keep going into the equity portion of the balance sheet, the shareholders' value increases.
Theoretically, the investor then needs to make guesses on two things: the amount of earnings a company will make over an extended period of time. The second guess comes from the interest rate value to use for the discounting of those earnings. Rather than go into great detail with examples, just understand that this is where buyers and sellers of a stock come from because the large institutional investors have models that crank out these values all day long. Let's say Investor A from Huge Institutional Investors, Inc. uses an earnings growth rate model of 20% a year for the next ten years on stock WXY, and then uses the interest rate of 5% as the discount rate for the value of those future earnings. That would give one price. If Investor B from Almost Gigantic World Investors, Inc. takes a look at the same stock and believes earnings will only grow at 10% a year for ten years, and then uses a discount rate of 8%, that will give a much lower valuation to the stock. (By the way, the higher the discount rate (the interest rate) used in the calculation of the stock price, the lower the price of the current stock. That's just one more reason why stocks go down when interest rates go up: it lowers the value of the future earnings stream.) In our example, investor A will see the stock at one price as a value, and investor B will see a much lower price as a value. If investor B owns the stock, she might sell it if the current price is well above the calculated value. If investor A doesn't own it, but the current price is below the perceived calculated value, then he would buy the stock.
So two sides have met in the market place, each with a different set of assumptions: the future stream of earnings and the discount rate. That's why there are buyers and sellers.
You're probably already saying things like "Yea, but earnings don't always come in as predicted, and what if interest rates go up, what then?" Earnings are rarely predictable, and when they're announced at less than expected levels, stocks get hammered (the models go to work and say the original assumptions were wrong, new data must be entered, and a new price has to be determined, a lower one.) If earnings are better than expected, it's the same process, only in reverse and the new price will be higher. Also, new growth rates will have to be assumed based on the announced earnings. Likewise, if interest rates go up, then the present value of those future earnings will go down (that means the price does, too), unless the growth rate of the earnings increases at a greater rate than the spike in the interest rates.
One more consideration: the premium for uncertainty in the earnings stream. That means that an investor will require a higher rate of return from an equity investment because it is not certain (the way a treasury bill or note or bond is). So if the treasury bill rate were 5%, then the equity investor would want to put a discount rate of 5% PLUS some more interest rate, say 1-5% more, depending upon the certainty of that future earnings stream. The more uncertainty in the company's earnings, the higher the discount rate, and hence, the lower the price an investor would be willing to pay for the stock.
And that's why there's so much fuss and focus on earnings.