Since the time I have started blogging, little over 6 months back, I was pretty determined not to let any Monday, Wednesday or Friday go post-less. I tried my best and persevered to keep up with the resolve. My perseverance lasted only the first week when it happily gave up to spending time with my nephew!
Now, rejuvenated after my holiday, let’s get back to making personal finance less intimidating and more approachable.
For a long long time, just the idea of stocks was scary to me. I had only vague references to stocks and wasn’t really willing to do any further research. Finally, my dads’ gentle pushing bore result and I invested a measly sum of Rs. 1,800 in my then employers stock. With that barrier gone, I really was drawn into and intrigued by the world of stocks.
From my experience, I know that just knowing about something makes it less intimidating to do. With stocks, the more you know, the more there is that you can dig deeper into. So, I am not going to claim that this post is a complete guide but it will definitely give you the basics to start understanding this wonderful investment vehicle.
What is a stock?
When a company wants to raise funding, they can choose to go public by offering shares to the public aka individual and institutional investors. While there is a long-winding confusing thread on Quora attempting to explain the difference between stocks and shares, for the sake of simplicity, I will use it interchangeably here.
There are 2 kinds of stocks issued by a company – preferred and common. Preferred stocks are, like their name, legally prioritized to be paid back in case of bankruptcy and also come with a right to fixed dividends. Common stocks, on the other hand, give you voting rights, possible dividends and lower rung right to be paid in case of bankruptcy. Both types of stocks are traded, albeit at different rates. Most people refer to common stocks when talking about stocks. Here, too, stocks will be used in a short-hand manner for common stocks.
Stocks are the building blocks of the equity market. They are a much higher risk and reward game than say mutual funds. The price movements for stocks are far sharper than ever for mutual funds.
Types of Stock Markets
Not all money traded on the markets goes to the company behind the stock. There are two kinds of markets:
This refers to the stocks issued directly by the company to raise funds. The most common form of stocks in this market is an IPO or Initial Public Offering whereby a company is newly listed on to the stock market. Research shows that IPOs are riskier than secondary trading as the company is untested and with no history on the market.
The secondary market is where most of the trading of stocks between individual and institutional investors really happens through the exchanges on which it is listed. Now, you can also see why the place of listing stocks is called an exchange!
For a long time, this trade was done on paper and the broker was a vital player in the transaction. Today most shares are kept in the dematerialized form and traded electronically.
Indian Stock Market
Any stock market is characterized by the major exchanges on which shares are traded. For instance, the biggest market in the world, the US stock market is known by it’s two biggest exchanges – NYSE (New York Stock Exchange) and NASDAQ (National Association of Securities Dealers Automated Quotations).
Similarly, in India, the two biggest exchanges are BSE (Bombay Stock Exchange) and NSE (National Stock Exchange), open for trading between 8:30 a.m. to 3:30 p.m. on Monday to Friday (apart from market holidays). Thankfully Bombay was not changed to Mumbai to turn BSE into MSE!
A lot of stocks are listed on both exchanges to maximize trades. Found this really interesting infographic which shows that both BSE and NSE are literally sniffing at the top 10 exchanges of the world! Something to be proud of, eh? J (P.S. Data last updated about a year ago)
Types of stocks
Stocks are divided into 3 categories on the basis of their market capitalization.
- Large-cap stocks: These are stocks of large, behemoth companies having a market cap of over Rs. 20,000 Crore (Source: IIFL)
Most of these companies are stable with an established business and prior track record leading to lower risk. However, they often have less room to grow considering a saturated market which simultaneously means a probability of lower returns. In India, stocks like TCS, Axis Bank and HUL count in large-cap stocks.
- Mid-cap stocks: These are companies with market cap between Rs. 5,000 and Rs. 20,000 Crore. While not very big yet, these companies have a potential to grow much faster than large cap companies.
- Small cap stocks: These are the smaller companies on the exchange with market cap of less than Rs. 5,000 Crore. These companies are still in growth phase and potential growth rate is quite high. However, the risk is equally high since smaller the company, easier it is to fold up and file for bankruptcy.
Important terms to know
1. Stock price
This is the price at which a single share of the company can be bought. For instance currently (May 7 before market hours), one share of ICICI Bank is quoted at Rs. 282.80 on NSE. However, the stock price is only a potential gain or loss on the stock you hold. It is realized only at the time that you sell. Hence even at times when the market falls, it’s not a loss for the shareholder till the time s/he actually sells the stock.
2. Market capitalization
Market capitalization is the value of outstanding stocks for a company. In simple terms it’s the number of public shares multiplied by the stock price. Market capitalization or market cap is used as a basis to segment the market.
A dividend is the money paid out from the profit to the shareholders. It is not mandatory for companies to pay out a dividend to the common stockholders but a lot of companies do declare the dividend. Dividend history is often an important consideration for people analyzing a company. It’s also one of the best streams of passive income (more on that later). Dividends are always paid out on the basis of number of stocks held.
4. Trading volume
This is the term given to the number of stocks sold and bought for a particular share in a given period. This is usually seen for a day. It is an important indicator of the liquidity of a stock as investors would want easy availability whenever they decide to buy or sell. In case you buy an illiquid stock, you could need to wait for some time to sell the share, just to find a buyer.
5. Stock Split
Often a company decided to split its stock in an effort to boost its trading volume. Consider 2 tyre companies: MRF trading at Rs. 75,694 and Apollo tyres at Rs. 285. MRF had 74 shares sold on Friday whereas Apollo Tyres had a selling quantity of 4643 in the market on Friday. I hold shares of Welspun India and was privy to the stock split of 1:10. Overnight my 10 shares increased to 100 and the share price of about 730 went down to 73.
6. Bonus share
Bonus shares are an alternative to giving out higher dividends. A company might decide to give out free shares to its shareholders in a certain proportion instead of higher dividends. So, if a company announces 1 bonus share for every 5 held, an investor with 20 shares gets 4 bonus shares.
There are 5 main rights that holders of common stocks get as shareholders:
1. Voting on major issues:
As a shareholder, you often get a chance to vote on major issues for the company, mostly at the Annual General Meeting or through an e-ballot.
2. Type of ownership in the company
A shareholder has rights to the profit generated by the company. He gets it either in the form of a dividend or in case of reinvested profits, in the form of higher stock prices.
3. Right to transfer ownership
This right is the one that allows trading of stocks to happen on the exchanges.
4. Opportunity to inspect company records
As soon as a company goes public by having its’ stock listed in the market, it is obligated to produce all its’ financial records and have them displayed publicly. This is a very important right as investors depending on fundamental analysis depend on financial information of a company.
5. Right to sue for wrongful acts
Since for all practical purposes, a shareholder is a part owner in a company, s/he also gets the right to be an external whistleblower of sorts. The current Chanda Kochhar fiasco was brought to light by one such shareholder.
Apart from the above, all stockholders are invited to and are welcome at the Annual General Meeting held by the company.
Sometimes, companies also give further perks to their shareholders. My father holds shares of the Oberoi group of hotels and once got vouchers to dine at their restaurant!
Types of analysis
Most seasoned stock traders or investors do their research before buying a stock. Though for some people, research could also mean talking to trusted partners like brokers, before taking a call (personally I am not a fan of not doing your own research).
There are 2 kinds of researches you can look at:
This research takes into account only the stock price and the trading volume. On the basis of a few trends with respect to the two parameters, analysts predict price movement and trade accordingly. This analysis is responsible for a lot of the price fluctuation and volatility in the market. Most day traders use this type of analysis as their bread and butter. To me, this method reeks of speculation.
This is a more detailed research where the investor looks at the financial numbers of a company and the reasons for it to be in news. In the case of value investing, seasoned investors often calculate the intrinsic value of a company to see whether the stock price is higher or whether the stock is available at a bargain. Today in the information age, fundamental analysis is far easier to do.
Most purchases made on the basis of fundamental research are for the long term as the investor has invested taking note of the underlying company and not a short-lived price trend. In this case, short-term price fluctuations do not end up impacting stock trading decisions for the investor.
If you have been reading my blog for some time, it should be easy to guess, which type of analysis I favor.
Like mutual funds, for stock market returns also, the story changed with Union Budget 2018. Till now, long-term capital gains of investment periods more than a year were tax-free. Starting April 1, 2018, any gains more than Rs. 1,00,000 in a financial year will be taxed at 10%. The acquisition cost of stocks bought earlier is grandfathered at or will be taken as on January 31, 2018.
Things to keep in mind while investing in stocks
- Know your risk appetite to decide whether to invest in small, mid or large cap stocks
- Research a company before investing
- Invest using extra cash and not the money required for household expenses
- Track prices at a frequency of every 1 to 3 months
- Do not be misguided by financial media to get caught up in short-term volatility
I hope this acts as a good initiation into what can be an enriching journey into the world of stocks.
Any questions or opinions? Let me know in the comments below or email me at firstname.lastname@example.org