Yes, it will be helpful to have a brief understanding of the market before we enter to build a portfolio and learn to manage it. I have seen most of the people who are either small or medium players of the market always claim that market is the place where you can lose your money. I believe that, it is just because of their lake of knowledge about the market and its functioning. Most of the people come to the market with the intention of making money thinking that it is possible in a short time span without any knowledge or responsibility. First of all you should create a mental attitude of a successful business man before you enter in to the market. And believe me no business in the world is a success with out a proper understanding of what your are doing. You should make a smart and effective plan before you put your money in the market. There is a way of dealing with your hard earned money with out a plan which is called gambling. So be a successful businessman and not a gambler. So let us try to understand the basic principles and concepts of share market.
What is a Share? A share or stock is a unit/certificate of ownership issued by a company. A person buys a share of a company become one of the owner of that particular company. The percentage of ownership depends on the quantity of the shares a person holds.
What is a Security? A security is a certificate or voucher having a financial value issued by the issuer to raise money. It can be easily traded in the market. Organizations issue the security is called the issuer. (for example, companies issue shares & debentures/ The government issue bonds.) Securities can be classified in two categories.
Debit Securities. It is nothing but financial instrument in the form of an acknowledgment given by the issuer confirming that the issuer has received a loan of the specified amount from the holder. The issuer pay the specified interest to the holder of a debit security. On the maturity the holder can return the debit security to the issuer and get back the principal amount. Examples of debit securities are bonds and debentures.
Equity Securities. If a person buys these securities he gets the ownership rights of the institution of which it belongs to and the value of equity security increase when that particular institution performs well with a good profit and growth. Examples of equity securities are shares. The holder will also get a part of its profits in the form of dividends.
Why Prices of shares rise and fall. Share prices vary due to the effect of demand and supply. The price rise due to higher demand and fall due to higher supply. Two reason which cause this demand and supply is performance of the company and effect of prevailing economic conditions. Investors can earn in two ways from investing on shares. one is by dividends paid by the company and the second is by the increase of the value of share in which invested.
Face Value & Market Value of Shares. Face value also called as book value or nominal value is the price of the share decided by the company when the value of the company itself is divided in a particular number of shares. Market value is the price in which the share of the company is currently traded in the market. Market capitalization of a company is = currunt market price (CMP) of a single share of the company multiplied by the number of shares of the company. Face value is mainly used as basic when dividend is distributed. The face value of a share changes on when the company splits it shares.
Classifying companies based on the size of their Market Cap. The listed companies are divided in to three according to their market capital. 1. Large Caps (Companies with large capital-in Indian market- Rs 50000 million or more) 2, Mid Caps (Companies with a medium capital - in Indian market - in between Rs. 10000 million and 50000 million) 3. Small Caps. (Companies with a small capital - in Indian market - below 10000 million) The fund invested in Large cap companies are believed with more stability by the wise investors.
Different Types of shares. There are two types of shares they are common shares and preference shares. common shares also called equity shares have voting rights and so they can influence the management of the company. But they have the least priority among all types of securities to receive dividend and liquidation payments. Preference share have no voting right thus cant participate or influence the management of the company. But they enjoy more priority than common shares to receive dividend and liquidation payments.
Priority of different type of securities to receive dividends and liquidation payments.
1. Debit securities like bonds, debentures have the highest priority
2. Preference share have the second priority.
3. Common or equity share have the last priority.
This comes very important when a company does not have sufficient fund to make the payment of dividend or liquidation payment. Let us try to understand this with an example. Suppose company A needs to pay 10000 lakh rupees each to bond holders, preference share holders and common equity share holders and the company is only having 15000 lakh rupees. In this case the bond holders will get the full dividend and the balance 5000 laksh rupees will be equally divided in to the preference share holders and the common equity share holders will get nothing. This is the same case which happen when a company is getting liquidated.
Dividend Rate. When a preference share is issued the issuing company specify the rate at which it will pay the dividend. This is called the dividend rate.
Par Value or Liquidation Value. This is the value paid by the investor to the company to buy preference shares. This is the amount that a preference share holder can expect from the company to receive back in case the company goes bankrupt.
Hope I have not put you all in a puzzle detailing all this. We were ready to manage a portfolio . So let us keep our knowledge of market functioning as a tool to select shares. We will discuss Portfolio management in next post. Mean while I will invite your attention to a chart which shows the last 7 years performance of NIFTYBEES an INDEX-ETF. Just go through the chart, try to learn and understand something and start dreaming BIG.
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