You must have heard stories of the fabulous returns made in the stock markets in recent times. And you longed wishfully for a piece of the action. But you could also have heard horror stories of how a man lost his everything in the stock market. And were promptly thankful that you didn’t lose yours.
Wisely chosen (those are the key words), stocks are a must for any serious investor. They add that extra zing to your collection of investments.
Study after study has revealed that over the long term, stocks outperform all other assets. That means you can expect to earn more from shares than from bonds, fixed deposits.
No doubt the risk is higher with shares. But if you are in for the long haul, so are the potential returns. But before you take the plunge and invest in the stock market, get your basics right.
In this chapter we will tell you about the basics of investing in stocks.
STOCKS ARE FOR ALL
Stocks are far from being space science. The strategies you need to know to maximise your wealth and the pitfalls you need to avoid are not beyond comprehension.
Even if you feel that you don’t have the time, and prefer to entrust your money to a portfolio manager or mutual fund, the least you need to know is which funds are better, how to choose your fund manager, and keep a tab on his performance.
SO WHAT IS A SHARE?
Any business has a lot of assets: The machinery, buildings, furniture, stock-in-trade, cash, etc.
It will also have liabilities. This is what the company owes other people. Bank loans, money owed to people from whom things have been bought on credit, are examples of liabilities.
Take away the liabilities from the total assets, and you are left with the capital.
Assets – Liabilities = Capital
Capital is the amount that the owner has in the business. As the business grows and makes profits, it adds to its capital.
This capital is subdivided into shares (or stocks).
So if a company’s capital is Rs. 10 crore (Rs. 100 million), that could be divided into 1 crore (10 million) shares of Rs. 10 each.
Part of this capital, or some of the shares, is held by the people who started the business, called the promoters.
The other shares are held by investors. These investors could be people like you and me or mutual funds and other institutional investors.
WHAT DOES THIS MEAN ?
You must have realised by now that owning a share means owning a share in the business.
When you invest in stocks, you do not invest in the market. You invest in the equity shares in a company. That makes you a shareholder or part owner in the company.
Since you own part of the assets of the company, you are entitled to the profits those assets generate. Or bear the loss.
So, for example, if you own 17 shares of Reliance Infocom, you own a very small part — since Reliance Infocom has millions of shares—of the company. You own a share of its assets, its liabilities, its profits, its losses, and so on.
Owning shares, therefore, means having a share of a business without the headache of managing it.
Your Reliance Infocom shares, for instance, will rise in value if the company makes good profits, or may do badly if people reduce using tele-communication services.
WHAT IS RISE IN VALUE?
If the company has divided its capital into shares of Rs. 10 each, then Rs. 10 is called the face value of the share.
When the share is traded in the stock market, however, this value may go up or down depending on supply and demand for the stock.
If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and many want to sell the shares, the price will fall.
The value of a share in the market at any point of time is called the price of the share or the market value of a stock. So the share with a face value of Rs. 10, may be quoted at Rs. 55 (higher than the face value), or even Rs. 9 (lower than the face value).
If the number of shares in a company is multiplied by its market value, the result is market capitalisation.
For instance, a company having 10 million shares of a face value Rs. 10 and a market value of Rs. 30 as on May 31, 2008, will have a market capitalisation of Rs. 300 million as on May 31, 2008.
HOW TO BUY SHARES?
Alright, you have decided you want part of the action. Shares are bought and sold on the stock exchanges — the two main ones in India are the National Stock Exchange (NSE), and the Bombay Stock Exchange (BSE).
You can use three different routes to buy shares: Through your broker, trade directly online, or buy shares when a company comes out with a fresh issue of shares. This is called an initial public offering (IPO).
