Wednesday, 25 April 2012

B for Basics - Beginner's guide to Stock Market

Investing in stocks is a really good option to create wealth over the long term. It is easy to learn to invest in stocks and also keeping track of your investments. Investing in stock markets is as important as parking your money in certain other traditional financial instruments. However it is important to get the basics right. So this post is for the beginners to clear concepts about stocks and stock markets.

What are shares? Shares/stocks/equity all mean the same thing. It is a part (albeit a very small part) of the ownership in any company. Lets take an example. Lets say that Sonu and Monu want to start a financial services company Glittering Gold. Each partner invests Rs. 50000/- each in the company. Now, the total money invested by the two partners is Rs. 100000/-. This is called the Capital Investment or Promoter’s Capital. Each partner by virtue of investing equal amounts in the company now becomes 50% partners and Glittering Gold comes into existence.

          As time went by the promoters of the company wanted to expand their business and grow even more. For this ambitious project they need more investment.

Initial Public Offering (IPO) :

The capital needed for expansion of the company can be raised in many ways. They can rope in more partners for this from known circles for this venture. Otherwise they can make the general public as shareholders in their venture. This second route is realised by listing the company i.e. issuing an Initial Public Offering of shares of the company.

When a company issues an IPO, the company is inviting the public to invest in their venture and become a part of their growth. If the company makes good of the investment and becomes profitable then in all likelihood it will share its profits with all the investors, in this case the public.

To do this the company has to issue a certain number of shares out of the total share capital.

Face Value of Share :

Remember the initial investment of Rs. 1 lac/-. In order to issue an IPO the promoters divide this initial investment into equal number of shares. If the company is dividing the initial investment into 10000 shares then each share will have a value of Rs.10/-. This is known as the Face Value of the share.Of this 10000 shares the promoters decide to keep 80% for themselves and decide to give the remaining 20% to the public in the IPO.

Promoter Issue Price :

Depending on the past performance of the company, the future vision, the current profit and loss, the relevance of the company in the long term etc., a price band is fixed for each share, lets say Rs.300 to Rs.360. This price unlike the Face Value as described above is called the Promoter Issue Price of each share.

The exact price at which the share is sold depends on the sentiment of the investors and trust on the company. Lets say the shares are issued at a price of Rs.300/- per share. Immediately the promoter’s holding share value increases by 8000 * 300 = 2400000/- by virtue of the market price of each share. Also they get an additional amount of 2000 * 300= 600000/- from the public for their growth plans. 2000 shares of Rs.10 each represents 20% of paid-up equity share capital of the company.

Once the shares are sold to the public and the proceedings are finalised Glittering Gold becomes a listed company in Stock Exchanges like BSE and NSE. Stock Exchange is an institution that facilitates the trading in stocks.

Market Price of Share (also known as Current Market Price) :

After listing, the share price will vary depending on the investors’ reaction to the company performance and many other conditions and situations. This price of the share in the market is know as the Market Price of each share and unlike the Face Value this price is variable. If the company performs well then the price of each stock or share may increase. If someone decides to sell their stake once the stock price has risen to Rs. 400/- then he will book a profit.

Dividend :

If the company makes a profit, it may decide to distribute a percentage of the profit equally amongst all shareholders. This is known as Dividend.
In some cases the company may not immediately declare a dividend but use the profits entirely for growing the business and thus leading to an increase in the investment value as a whole which will be reflected in an increase in the stock price over a period of time depending again on investor sentiment or better known as market sentiment.

Earnings Per Share (EPS) :

The amount that remains after deducting the deductibles from the revenue (sales/topline) of a company is called the Net Income of the company. We can deduct an important parameter from the net income of a company known as the Earnings per Share (EPS).

EPS equation

EPS is an important factor in determining the performance of the company and also affects the market price of the shares.

Learning to invest in stocks starts with knowing about the different terminology used. In this post we have tried to explain many such terms which we need to know as beginners to investing in stocks. You can go through the sections for Beginners and Learn to Invest to know more. Keeping with the spirit of this blog, we will continue to explain many such concepts and terms so that investing in stocks is simplified.