Tuesday, 15 July 2014

A beginner's guide to share markets

What is a share?

The terms share, stock or equity all mean essentially the same.

Every company has 2 major sources of funding – Money contributed by owners & Money borrowed from others.
  • Money borrowed from others is called debt, & includes banks loans, loans from bond investors, loans from other financial institutions, etc.
  • Money contributed by owners is called equity. The company takes money from owners and gives them shares of the company. These shares give an owner a proportionate ownership of the company’s net profits and its net assets. The share of an owner is proportional to the amount of funds he has contributed to the total equity.

 These shares can be traded by owners with others through a stock exchange or directly.

Market capitalization of a company is the total value of its shares at market price. Suppose the company has 1 crore shares trading at ₹ 50 each, the market capitalization of the company will be ₹ 50 crores.

What is a stock exchange?

Stock Exchange is a marketplace where regulated trading of shares of companies happens.

The 2 biggest stock exchanges in India are Bombay Stock Exchange (BSE) & National Stock Exchange (NSE). These exchanges do the job of bringing together buyers and sellers of shares.

In the earlier days, the selling used to be physically done where buyers and seller shouted their prices. Now it is done electronically. Buyers and sellers can quote their prices on computer screens and depending on the market price, the transaction happens.

Why does the price of a share increase or decrease in the market?

A listed company earning profits in a year, gives some proportion of the profits back to owners as 'dividend' & keeps the rest with itself to reinvest for higher growth. Thus, owners of shares get some cash as dividends in the year and they are also entitled to dividends in the future.

The value of the share accounts for all the dividends the investors will receive now and in the future.

  • In periods of pessimism or low growth outlook (called bear run), the investors feel that future dividends will not be as high as what they earlier thought, and so the value of the shares decrease.
  • In periods of optimism or high growth outlook (called bull run), the investors feel that future dividends will be higher than what they earlier thought, and so the value of the shares increase.

Since every investor has a slightly different view on how much a company & the overall economy will grow, the prices tend to change every instant. The long term change in the value of the shares depends on the sentiment of majority of investors in the markets.

What are Sensex & Nifty?

SENSEX is just an index of BSE & is not the share of any company. It shows the overall price movements of the shares of top 30 largest companies listed on Bombay Stock Exchange. Thus it gives an indication of the direction in which markets are moving.

Nifty is an index of NSE and like Sensex it shows the price movement of the shares of top 50 largest companies listed on National Stock Exchange.

There are many other indices like BSE 100 for stocks of top 100 companies, BSE Mid Cap for all medium sized companies, etc.

Why should I invest in shares?

Stock Prices depend on the earnings of companies. As GDP of economy increases, the earnings of all companies will also increase. As earning of companies grow, the prices of stocks also increase.

Source: NSE Website

In the past 15 years, the earning of top companies increased by about 6 times and hence the value of the shares of the companies also increased by about 6 times.

Nifty gave returns of 13.1% for 15 years & it is also tax free. In comparison, returns on Fixed Deposits have been in the range of 6 to 8% after tax.
Thus if one is optimistic about the Indian economy and Indian companies, one should invest in share markets.

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