Shares & Stock Markets
THAT’S AN ENTIRELY PERSONAL QUESTION !
Should you invest or trade in stocks? The answer to this question is entirely personal and it would depend on lot of factors.
However, we will not recommend trading to anyone. In our opinion, shares should be considered as a long term investment.
The reason why we don’t recommend trading is that, in our experience, most of the traders ( especially beginners) feel that it’s quite easy to buy at lows and sell at highs. But, it’s not so. Trading is a highly technical activity. Newbies tend to underestimate the difficulties of day trading and overestimate their ability as a beginner. 90% of them lose money and get out of the markets in the first 2 years.It would be better to study the fundamentals and try to invest ( at least for a short term) rather than doing day trading. However, It’s your money and the decision is yours. What we can do is, we’ll list out some suggestions based on which you can take a decision whether to trade or invest or do both.
- 1. People who cannot monitor the market regularly should not get into share trading. Share trading requires constant monitoring of price, volume, trend etc.. Most of us may not have the tools to analyze all these factors on a real time basis.
- 2. Young guns out there who cannot actively take part in share markets should start investing small amounts in shares. The idea is to accumulate small amounts of shares that will eventually grow into millions. Young investors can also consider trading in shares for short term profits to build up their capital initially.
- 3. Those who are planning to be active in share markets should allocate their available funds into two categories- one part for investing and the other part for trading.
- 4. If you are nearing retirement and haven’t started saving, heavily investing in the stock market is probably not a good idea. However, if you have enough funds to meet your financial requirements for next five years, you may enter into stock markets.
- 5. Markets are always risky in the short term. Hence trading involves more risk than investing. Markets will keep moving up and down and it’s easy to get emotionally disturbed when you keep watching those price fluctuations.
- 6. Investing, if done right, would result in huge results in the way of capital appreciation, dividends, bonus shares, rights issue etc. trading does not have such advantages. Trading results depends on the price movements and how well you time the market.
- 7. Short term profits or trading profits are taxable income in India. Where as profits from long term investments are tax free.
- 8. Trading tends to become more speculative as you try to make profits from every price movement. Some of these price movements may be due to rumors or manipulations and it’s easy to get trapped in such situations. When you invest, you take a lot of time to study the fundamentals and about what’s happening around. Hence it’s highly ulikely that you get into such traps.
To trade or to invest in stock markets would depend on one’s age, nature of income and attitude. In any case, you should go by the fundamentals supported by the technical factors. Technical analysis and fundamental analysis are seen by many as polar opposites but many market participants have experienced great success by combining the two. Having both the fundamentals and technicals on your side would only have advantages. We will be discussing in detail about fundamental analysis and technical analysis later on.
SHARES OR STOCKS?
That’s right. The first step is to clarify that point. ‘Shares’ and ‘stocks’ mean the same thing. Shares are collectively called stocks. So if your friend says that he owns stocks, what he means to say is that he has bought shares in many companies. But if he says he owns shares, he’s being specific there. What he means to say is that he has bought shares of a particular company.
CHARACTERISTICS OF SHARES
Shares have these following distinctive characteristics:
When you buy a share, you are buying a piece of that company – you become its part owner. That ownership gives you certain rights, including voting on important matters of the company and participating in the profits.
High profit potential.
When you buy stocks, you become the owner to that extent and when the company makes more and more profits and expands, the demand for its shares will also rise. As a result, the share prices also move up. As an owner, you already have rights in its profits. Now, as the demand for the shares goes up, a second benefit in the form from of appreciation in capital invested opens up.
For example: Many of the early employees of Infosys are millionaires because their stock has gone up dramatically.
However what if the company dint make profits as expected? There won’t be much demand for it’s shares nor it will carry a high rate of profit share. Hence, along with the potential for extraordinary gain comes the potential for high loss. These two go hand in hand. If you are not careful in choosing a company, you can lose money by investing in stocks. Not only in stocks, in fact, have even the safest savings deposits carried unseen risks. When you account for inflation and taxes, you’ll find that most of the so called risk free investments are not so safe.
Source of Income
We have already explained that. Since share holders are part owners of the company, they are entitled to get a part of the annual profits of the company. Shareholders get income by way of dividends and bonus shares.
- Shares and stocks mean the same thing. Shares are collectively called stocks.
- Shares give you right to ownership, voting, decision making and profits in a company.
- Investment in shares can be risky if recklessly done.
- Share investments have the potential to make you millionaires.
- It gives you income in the form of dividends and bonuses.
The first step for anyone who aspires to invest in stocks , is to understand stocks ! The words stocks and shares mean the same thing. Share means a portion of anything. In our context, share means a portion of ownership of a company.Now,it would be better to discuss this concept with the help of an example. This will help you to get a clear idea of what a share is. Lets try to explain that with the story of a company called ‘Say-it-with-flowers’.
SCENE 1- The beginning
A group of girls decides to start a business. Since they knew floral decorations, they decide to start a flower shop. They name their business as ‘Say-it-with-flowers’. For initial expenses, they borrowed some money from the local bank and opens their shop in a small space. The business was successful. However, they made little profit because; all the earnings were invested back into business since the customers were increasing and they had to meet the growing demand for their floral decorations.
SCENE 2- A decade after.
Ten years later, the bank loan has been paid off. Profits are over Rs 10 lakhs per year. It also has a book value of Rs 50 lakhs. (Book value is the net value of what the company owns- machinery, furniture, building less any loans). Having made their business a success, the girls now wants to expand their business. Their idea is to open two more branches at neighboring towns. After a detailed study, they find out that it’s going to cost over Rs 52 Lakhs to open two outlets. To find this 52 lakhs, they had two options- one, take out a loan from the bank. Two, sell part of their company. Since interest rates are high, they decide to take the second route. But how? What would be the cost of a share in say-it-with-flowers? Who will do the valuation? There were several questions to be answered.
SCENE 3-The big leap
To sell part of their company, the company has to be valued. The person who values a company is called an ‘underwriter’. So they approach an underwriter who checks their past records, future prospects, background of the promoters etc, The underwriter decides that the company is worth 10 times its current profits.
The current profits is 10 lakhs. So 10 times 10 lakhs is 1 crore. This one crore is actually an estimate based on various qualitative factors. Add book value to it, and you arrive at Rs 1crore and 50 Lakhs. This means, “Say-it-with-flowers” is worth Rs 150 lakhs.
40% of 150 is 60 lakhs. So, the girls decide to sell 40% of their company.A group of investors who were willing to buy the 40% shares in that company gives a check for Rs 60 lakhs. The girls still have control over the operations of the company since they still have 60% share.
SCENE 4- The benefit
Now, For the girls, 40% stake is lost but they get 60 lakhs in cash. They have the money to expand their business.As planned, they opened two new outlets for Rs 52 lakhs.The balance 8 lakhs is used for day to day operations of the three shops.
Both the new stores hit a profit of 10 lakhs a year. That means the total profit of the company Say-it-with-flowers is now Rs 30 lakhs. ( 10 lakhs x 3 shops ). The value of the business is now Rs. 450 lakhs (3 shops x 10 lakhs x 10 times + 50 lakhs x 3) and the couple’s 60% stake is worth Rs 270 lakhs.(450 x 60%)
SCENE 5 – At the stock market.
Since the investors who bought 40% of the share for 60 lakhs, is now worth 180 lakhs, the shares of say-it-with-flowers is in great demand. Since the company increased the wealth of shareholders 3 times, there are investors who are willing to purchase the shares even for an amount higher than 180 lakhs. Each day, shares of say-it-with-flowers are sold to the highest bidder. The place at which the bidding and buying process takes place is called the stock market.
SCENE 6 – You as an investor..
Let’s assume that the total shares of the company are 50,000 shares. So, 40% available to the public is 20,000 shares. The issue price was Rs 300 (60 lakhs/20000) but, now the share is worth Rs 900(180 lakhs / 20000). Since a section of the public feels that this winning streak of the company would continue, there is heavy demand for the share and due to this, the price keeps moving up.
Suppose the price is Rs 1250 now. Should you buy?
The answer is –no. Why? Because, the shares are trading above the ‘real value’ of Rs 900. This real value is also called ‘intrinsic value’.
Price drops to Rs 750. Should you buy?
Now, one day, due to some rumors, the stock market crashes, and consequent to that, the price of the share plummets to Rs 750 per share.
Should you buy? May be, yes! Why? Because, now the share price is below the real value and some time later , you can expect the rumors to settle and that will result in the prices moving back to it’s original level of Rs 1250 or more.
Where should you sell?
Although the price may move back to Rs 1250, your selling point theoretically should be at Rs 900 . Why? Because that’s the actual value point. The price rise above Rs 900 may be due to several reasons like investor sentiment which should be ignored.
The good investor’s job is to identify companies like say-it-with-flowers that are selling below their true worth due to some illogical reason and invest in such stocks.
Hope We’ve made it clear.
From this post onwards, I am going to kick off the discussion on shares as an option to create wealth. Let me start by saying 7 straight truths about stock markets.
First, nobody gets rich quickly in stock markets. Some of your friends might have blindly invested in some stocks which, to their luck, gave them exceptional profits. Yet, they never became rich. Did they? So that’s the first truth about stock markets – it’s not a place where you get rich quickly.It takes time to grow your money.
Second, it isn’t easy for beginners to make money on the stock exchange. If it was such a simple exercise, Mr. Warren buffet wouldn’t have become so famous. It takes genuine effort to spot profitable investments.
Third, your broker, friends, neighbor, colleagues et al would come up with ‘sure shots’ everyday; there are too many stock analysts out there giving out fee based stock recommendations. It’s easy to get tempted by all these people around you. After many years in the market, my thoughts keep wavering when somebody comes up with such ‘sure shots’. Should I explain the fate of a beginner? It’s important to stay off from these temptations. It implies that you ought to have ‘independent thought’. Independent thought is something very hard to carry through.
Fourth, most of the investors are a bit too casual with stock markets. They ‘play’ in stock markets. Stock exchange is a wrong place to have fun, speculate and try luck. The Stock market is actually a place dominated by big investment houses and financial experts. This is a place where the world’s brightest finance professionals put their best efforts to make right investment decisions. Nobody is playing around. So, to be successful, you too, need to be serious. You have to view it as a business. When you buy shares, you are buying a company to that extent. Buying a company is no Fun!
Fifth, realise the fact that broker’s income is the commissions you give. The more you trade, the more they get. When I was serving as the manager of a broker, I used to get monthly targets for the volume of brokerage that should be generated. If I don’t do that, my salary payment gets delayed. Each branch was viewed as a profit center. Myself and my colleagues used to hit our targets but our investors rarely did! Most of the brokerage houses encourage their clients to do as many trades as possible whether it’s good for them or not, and keep doing it until you have used up all their money. If you get too many frequent ‘Sure shot market tips’ thru sms, mails and phone calls – think twice. Your broker may be interested only in generating commissions. Make sure you don’t get into such traps. Do have faith in your broker, but don’t blindly follow them. They can give you advice but they can’t guarantee that you will make a return on any investment in the stock market.
Sixth, as you begin to study the principles, you’ll hear about derivative instruments like futures and options. Instruments like options and futures are NOT for beginners with limited resources. They are highly technical, involve the potential to lose all of your investment quickly and need constant monitoring. Playing Futures and options without adequate working knowledge is like gambling at Las Vegas.
Finally, you have to keep on working on your stock picking skills. Keep following the market developments. You’ll also need to study some basics on economics, accountancy, income tax and mathematics.
So, # No quick riches in stock markets # it’s not the place to have fun with money # you shouldn’t be blindly believing your broker’s recommendations # never try your luck # and, learning is the only way -to make right choices in stock markets.
So, let’s begin from the roots. My next post would explain what shares are.
Before you take the plunge, think about what’s said above. To succeed in stocks, you’ll have to put maximum efforts to learn the game and be serious with investments.
May God help you to achieve your goals.
- Point Blank
- Financial Discipline for all.
- Investing Basics
- Shares & Stock Markets
- Introduction to Financial Statements
- Financial ratios.
- Stock investing strategies
- Technical Analysis I
- Technical analysis II
- Before Picking up stocks..
- Choosing a Broker and opening Demat Accounts
- Make your debut !!
- More ... from stock markets.
- Valuation of shares
- Futures and Options - The basics.
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