Before reading this lesson, you should have read through:
A country's government shapes the business environment in which companies operate.
Government policies such as changes to regulations, taxation, interest rates and spending programmes therefore have a huge influence on individual companies' performance and theirprice.
This lesson will show you how these government policies influence the price of shares.
Understanding this influence and making use of this knowledge may help you prosper. No way to do it without practice though!
Governments are responsible for regulating certain industries such as banking, insurance and telecommunications.
Governments sometimes change the legislation that will make it easier or more difficult for a particular sector to perform well.
For example,in most countries are required to hold a minimum amount of customer deposits in cash reserves.
Increasing this reserve requirement can mean a bank has less money to lend out to businesses.
Being able to lend less means that a bank earns less. This can therefore have a negative impact on bank share prices.
Because of the interconnectedness of the economy, changes to the rules governing one sector can also impact on the health of companies in another sector, and their share prices.
Raising banks' reserve requirements for example has an impact on individual companies, which often rely on bank finance to fund their own growth. Reducing companies' ability to borrow from banks can therefore pull down their share price as well.
However, the opposite can be true. If a government lowers the reserve requirement, then this can have a positive effect on the share price of banks and companies that are exposed to borrowing costs.
It is prudent, therefore, to keep and eye on legislation that could affect the share price of the companies that you consider.
Every company is subject to various forms of taxation, either directly or indirectly, and changes in taxation will affect their performance and share price.
A change to the corporate tax a company must pay is probably the most obvious to look out for as this will directly impact how muchit makes.
An increase in corporate tax can even force a company to relocate in order to find a more favourable tax regime in which to operate.
Taxes on specific goods or resources can also impact on the profitability – and therefore share price – of related industries.
For example, if the government raises fuel tax, companies like airlines or couriers that use a lot of fuel can see their profit margin eroded.
These companies may then choose to pass on their higher fuel costs as higher prices for customers. This could hit demand for their products or services, and therefore reduce their revenue.
Therefore, when you are looking at a company and considering whether to buy or sell its shares, you should be aware of not only any specific tax changes that may affect its profitability, but also any tax changes on the resources that the company uses.
refers to the control of supply in the economy and governments use it to either stimulate or cool an economy that they think is growing too slowly or is suffering from high .
One way of stimulating an economy is for theto lower . This reduces businesses' and consumers' borrowing costs, which frees up cash for spending and .
Lower interest rates will therefore tend to boost share prices as a company has lower costs and can invest more in its future growth while consumers have more money to spend on its goods or services.
In contrast, raising interest rates tends to increase a company's costs at the very time that consumers have less money to spend on its goods and services. Raising interest rates can therefore push down corporate share prices.Governments can also buy to flood the economy with money. This is also referred to as printing money.
Quantitative easing is slightly different to this and involves the government buying financialfrom commercial banks and other institutions to inject money into the economy.
Increasing the money supply tends to lift consumer spending, so can have a particularly positive effect on the share prices of companies in the retail sector, for instance, which tend to see their revenue rise at these times.
Fiscal policy is where the government undertakes spending programmes to stimulate the economy, for example through big infrastructure projects.
Different sectors will feel the benefit depending on where government spending is focused.
If a government invests more in areas such as affordable housing, for example, the share price of construction companies can be the first to benefit as they win new business building homes and roads.
You should therefore consider how any government announcements of increasing or decreasing spending could affect the profitability of the company you watching.
In this lesson you have learned that …
- … a country's government shapes the business environment in which companies operate, so its policies – changes to regulations, taxes or interest rates – have a huge impact on individual companies' performance and share price.
- … governments are responsible for regulating certain industries and will sometimes change legislation making it easier or harder for a particular sector to perform well.
- … every company is subject to various forms of taxation and changes here will affect its performance and share price.
- … lowering interest rates is one way the government has of stimulating the economy – it tends to boost share prices as companies have lower borrowing costs and can invest more in their future growth while consumers have more money to spend on goods and services.
- … raising interest rates tends to increase a company's costs at the very time that consumers have less money to spend on its goods and services – this can therefore push down share prices.
- … buying government bonds or quantitative easing are other ways the government can inject money into the economy – this tends to be good for banking and retailer shares.
- … government spending programmes can boost companies' share prices by creating more demand for their goods and services.
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