WHAT IS THE STOCK MARKET?

All of us have a deep driving desire to improve the quality of our life, and we always seem to need more and more money to fund these desires. Stocks and shares seem to be one way of fulfilling that need. The world of investments is indeed a fascinating one to learn about. Let’s take a look at where the markets’ journey started in India. The Indian stock market is about 200 years old. In 1854, with the rapidly developing share trading business, brokers used to gather at a street now well known as Dalal Street for the purpose of transacting business. The Bombay Stock Exchange (BSE), the oldest stock exchange in Asia, was the first stock exchange in the country to be granted permanent recognition under the Securities Contract Regulation Act, 1956. The trading scenario in India underwent a paradigm shift in 1993 when the National Stock Exchange (NSE) was recognized as a stock exchange. Within just a few years, trading on both the exchanges shifted from an ‘open outcry’ system (which literally involved shouting across the trading floor to transfer information about buying and sell orders) to an automated trading environment. But before we go any further, let’s first stop to understand what the stock market is an how it operates. We all know what the market is. There are vegetable markets, fish markets, real estate markets, and so on. A market is a common place where buying and selling of goods and services take place between a buyer and seller, directly or indirectly through intermediaries and facilitators. A stock market is a place where shares are bought and sold. Of course, with the advent of the internet and related tools and technology, the market can exist even if the buyers and sellers are not physically present in it. The stock market, share market, and securities market are interchangeable terms used in the investment world. ‘Stock market’ or ‘share market’ refers to the market for equity shares, while the term ‘securities market’ encompasses the market for equity shares, bonds, debentures, gilts, and other securities. The stock market can be split into two main sections: the primary market and the secondary market. The primary market is where new issues are first sold through Initial Public Offerings (IPO). All subsequent trading goes on in the secondary market, where participants buy and sell stocks.

Let’s take an example here. Mahesh applied for the IPO of a company ‘XYZ’ and received an allotment of 100 shares. Now, he is wondering whether to sell, hold, or buy more shares of the same company. In

order to take an appropriate decision, he must have some price information about XYZ’s shares. At this juncture, he is curious to know the current price of the shares of XYZ. Satisfied with the price, he decides

to sell the shares. But first, he needs to find a buyer. He also needs to ensure that the transactions are transparent. Stock markets address issues such as:

1) Providing price information for trading decisions.

2) Acting as a bridge between buyers and sellers.

3) Ensuring marketability and liquidity for the shares.

Stock Market

Put succinctly, it will be difficult to find investors willing to invest or participate in equity shares in the absence of stock markets. The price of a share at any given stage is dictated by supply and demand within the market, and rises or falls every time a share is bought or sold. This effectively means that shares are priced by the collective will and attitudes of the market, which comprises all the traders and investment houses that actively trade-in those securities.

WHAT ARE SHARES?

To start a business, there are many requirements such as product/service idea(s), an operational facility, and people to work, etc. All these activities imply that the company needs money or ‘capital’. Companies raise this capital mainly in two ways:

• Borrowings.

• Raising money from investors by selling them a stake (issuing shares of stock) in the company.

The second method of raising money is how stocks come into existence. A share of stock is literally a share in the ownership of a company. When you buy a share of stock, you are entitled to a small fraction of the assets and earnings of that company. The assets include everything the company owns (buildings, equipment, trademarks), and earnings are all the money the company brings in from selling its products and services. All public limited companies are started privately by a promoter or a group of promoters. Often, though, the promoters’ capital and the borrowings from banks and financial institutions are not sufficient to finance a project or set up a business. So, these companies invite the public to contribute towards equity and issue shares to these individual investors through an Initial Public Offer (IPO). Shares bought through an IPO issue are again traded by investors in what is called the secondary market. The secondary markets are generally called the ‘share market’. The share market is like any other market, wherein prices are determined by the forces of demand and supply. Demand refers to how many people want to buy something and how much they are prepared to pay for it. Supply refers to how many people are prepared to sell something and the price they want for it.

WHY INVEST IN EQUITIES?

Why do people buy shares? If you look at the long-term history of the markets over long time horizons, stocks have provided consistent returns and have been solid investments overall. This is to say that as the economy has grown, so have corporate earnings, and stock prices are linked to the performance of the company in the long run. Obviously, then, making money is the main motivation for investing in shares. This can be divided into two parts – the expectation of dividends and capital gains. As long as you hold shares of a company, you are eligible to receive any dividends that the company may declare, which typically happens when it makes profits. The dividend is the investor’s share of the company’s profits and is declared in proportion to the number of shares owned. Remember that dividend is computed on

the face value of the share. Therefore 20 percent dividend of Infosys share means that you will not get 20 percent of the market value but 20 percent of the face value. In the case of Infosys, this is Rs 5 and therefore you will get Rs 1 for each share. The dividend is generally paid to you by cheque every six months.

Capital gains are another important way of making money from shares. For example, if you buy a share of a company for Rs 150 based on its strong fundamentals, and you sell the share when it is trading at Rs 250, your capital gain is Rs 100. People invest in stocks expecting capital gains as stock prices tend to go up over the years as the companies grow. However, unpredictability is a hallmark of the market, and there is no guarantee that the share value will appreciate or that there will be dividends. Loss-making or companies with marginal profits do not declare dividends. Share prices may also come crashing down due to unexpected market conditions, which will effectively mean a capital loss. In a particular period, there may be appreciation and/or dividends, and in another, investors may get only one of them or neither of them. A case in point is the sudden fraud that was unearthed in Satyam Computers some years ago. When the company’s fudging of its books went public on January 7, 2009, the company’s stock prices of the company went down by 78 percent. That was a tremendous capital loss to the respective companies’ shareholders. What may help investors is to learn more about certain other key variables, viz. earnings per share (EPS), price-to-earnings (P/E ratio), market capitalization, projected earnings’ growth for the next quarter and some historical data, all of which speak volumes about what the company has done in the past. Get the present status of the stock movement such as its real-time quote, average trades per day, the total number of shares outstanding, dividend, highs and lows for the day and for the past 52 weeks. This information should cumulatively give you an indication of how the company has fared and the stock movement. In short, the next time you hear or read a ‘hot tip’, do some research, try to find out all you can about the stock, and only based on that should you decide whether or not to jump into the stock.