In the financial markets, a share is a unit of ownership in a corporation. It could also mean a unit of a mutual fund, limited partnership, or a real estate investment trust. A person owning the shares of a company is called a shareholder. Common shares and preference shares refer to two different types of shares. They both hold different rights and privileges, and trade at different prices. Common shareholders are allowed to vote in company decisions while preference shareholders do not have this privilege. However,preference shareholders have priority in repayment of investment if the company goes bankrupt. Both types of shares receive dividends, the dividends of preference shareholders is guaranteed and fixed, almost like a debenture.
The value of the share depends on the value of the company/fund. Growth in the revenue and profits of the company or the fund increases shareholders’ value. There are two ways shares can fetch value –
1) Through dividends: Stocks of many companies give out profits as dividends. These are generally cash rich companies with stable growth and many of the investors look forward to the dividends as a source of income. There are also some companies which promise dividends to attract investors to buy their stock.
2) Through capital appreciation: Most companies do not give out dividends, but reinvest the profits in the growth of the company itself. This translates to an increase in the share price of the company, providing value to investors in the form of capital appreciation.
A company can issue its stocks for the first time in the market through an Initial Public offering (IPO). The IPO is underwritten by an investment bank which advises on the price the stock should be sold at, and also helps in listing the stock on an exchange. This IPO is purchased by institutional and retail investors. Then the stocks are listed on the exchanges like National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India. A stock is traded on the exchange, and its price is determined by demand and supply in the market.
Institutional Investors, Fund Managers, Equity Research Analysts, Private Bankers, etc. make decisions on investing in various companies by evaluating the companies’ performance on the basis of their assets and liabilities, different ratios like liquidity ratios, profitability ratios, debt ratios, P/E ratios, management discussions and analysis, news reports, competitors, etc. This is called Fundamental Analysis of stocks.
Traders, on the other hand, study the price trends of the stocks on the exchange, the resistance and peak levels, the various indicators that signal where the price is headed, different patterns in the behaviour of stocks and give a short-term recommendation on whether the price is headed upward or downward. This is called Technical Analysis of Stocks.
Investing in shares, just like any other investment, comes with some amount of risk. Shares are considered riskier than other types of investments. The biggest risk of investing in shares is that it can result in loss of capital. Unanticipated events out of one’s control or negative developments within the company can greatly impact the share prices of a company. However, one can reduce the risks attached to investing in shares by choosing the right stocks, diversifying one’s portfolio and holding for the long term.
The long-term change in price of the share depends on the following factors:
Company specific factors:
- Changes in profits, revenues and estimated future earnings of the company, leading to changes in share price.
- Introduction of a new product which adds value to the product line.
- Securing a new contract/opening up a new factory which can affect the cost of production or sales.
- Anticipated takeover/merger, can lead to increase or decrease in share price depending on the management terms and conditions.
- Downsizing/automation, leading to lower costs and higher profits.
- Introduction of a new technology in the business, leading to improvement in quality or quantity.
- A change of management, etc.
- Industry performance, to which company share price is directly correlated in most cases.
- Investor sentiment, whether bullish or bearish will affect the share price directly.
- Interest rates increase can increase cost of debt for companies, reducing their profits, and consequently the share price.
- Inflation could have dual impact. Small amount of inflation can encourage production and profits, increasing share prices, but high inflation will reduce demand, leading to reduced share price.
- Eco-political triggers like change in oil prices, trade barriers and tariffs, or political shocks like terrorism can significantly affect the share prices of companies within that geopolitical area.
- Changes in economic policy, like immigration etc. can affect the cost of labour for the company, and translate to change in share price.
- Change in value of Rupee would influence FII inflows or outflows, significantly affecting share price.
Today shares of Indian companies are stored in dematerialized form and traded online on NSE, BSE and other local exchanges. Dematerialization is the process of converting physical share certificates into electronic form. Demat accounts can be opened with Depository Participants (DP) registered with the National Securities Depository Ltd. (NSDL). Online trading has significantly increased the liquidity of shares and helped in achieving fair price. Most wealth houses and brokers provide facility of opening demat and online trading accounts linked to bank account. This has become the most preferred form of investing in shares due to convenience of buying/selling and being less dependent on brokers for executing trades.
- What are the different kind of stocks available?
Stocks can be classified on many basis
On the basis of type of returns:
- Dividend paying stocks: which give out regular dividends to shareholders
- Growth stocks: which do not pay dividends, but reinvest the profits towards the growth of the company, which reflects in the price of the stock.
On the basis of size:
- Large cap stocks: First 100 stock on the basis of largest market capitalization.
- Mid cap stocks: 101st to 250th stocks on the basis of market capitalization.
- Small cap stocks: 251st company onwards, on the basis of market capitalization.
On the basis of volatility
- High beta stocks: Which are more volatile than the index
- Low beta stocks: Which are less volatile than the index
- What are value stocks?
Value stocks are those which have not yet attained their intrinsic value in terms of market price due to a variety of reasons. Value stocks can be identified on the following basis:
- Their Price to Earnings (PE) ratio must be in the lowest 10% of all companies.
- Its Price to Earnings growth ratio must be less than 1.
- Its share price must be less than its book value.
- Its Debt:Equity ratio must be 1 or less.
- Its current assets must be at least twice its current liabilities
- How can I invest in the stock market?
- To invest in stocks, you need a demat account, which helps you to buy and sell shares electronically without exchange of physical share certificates.
- You can open a demat account with any Depository Participant (DP) registered with National Securities Depository Limited (NSDL) or Central Securities Depository Limited (CSDL). This list is available on their websites.
- You can approach any of the broking houses who will open the demat account for you, and also place orders for you regarding buying and selling of shares.
- Alternatively, you can open a 3-in-one account comprised of a bank account linked with demat account and a trading account where you can execute the trades yourself.
- What is the role of SEBI in the shares market?
SEBI is the chief regulator of all the securities market in India, including share market. SEBI has set rules and regulations which protect the interest of the investors and ensure that there are no malpractices and fraudulent activities carried out by companies. All the stock exchanges fall within the regulatory ambit of SEBI, and it has the authority to audit their books of accounts. It keeps insider trading and price rigging in check to safeguard the investors interests.
- What is the role of brokers and intermediaries in the trading of shares?
Stock brokers have played a crucial role in making the stock market vibrant and active. Brokers can be individuals or broking companies/houses. Stock brokers keep track of market trends and give tips to their investors on what stocks to invest in. They are different from analysts, in that they do not study or analyse the fundamentals of stocks or make predictions about their behaviour. They in fact base their assertions on the analysts reports and help the investors execute the trades. There are two types of brokers – a) Discount Brokers who do not give advice but just help to buy or sell stocks, b) Full-service Brokers who provide advice and charge commissions for the same.
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Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing. Past performance is not indicative of future returns.
Please consider your specific investment requirements, risk tolerance, investment goal, time frame, risk and reward balance and the cost associated with the investment before choosing a fund, or designing a portfolio that suits your needs.