The vast intricacies in the money market got easier to explore after the first article in the Stock Market 101 series. Simple terms surrounding shares, stock exchanges, and market trading would’ve got you thinking about the Thrify to Nifty catchphrase.
Well, yes, it’s a given that individuals with minimal experience in stock investing are bewildered by stories about the average investor losing half their portfolio value—for example, in the two bear markets that have occurred this millennium. In other instances, they’ve been lured by “hot tidbits” that promise huge profits but rarely deliver. Contrastingly, the reality is that while investment risks and volatility of the market make it tricky, it can be one of the most efficient methods to increase one’s net worth.
Let’s imagine you’ve laid aside a few thousand rupees and are ready to delve into the world of investing. Perhaps you only have a few hundreds extra every week and want to save before you start. When approached correctly, investing this money would be a strategy to set aside money and have it work for you to maximise its benefits later. Some of the terms might be technical and far out as you read ahead, but your understanding of the market will augment with time.
WHAT IS A TRADING AND DEMAT ACCOUNT?
As you might already know, the market sees the involvement of companies. The company or a stakeholder selling their shares are the sellers, and the investor is the buyer. A trading account is essentially the account through which you transfer the money to the seller. The seller transfers the shares into your Demat account, so a Demat is essentially an account that holds your financial securities in electronic form.
Back in the day, buying and selling used to be cumbersome, but now, we have trading platforms that ease this process. These platforms differ from each other in one-time security deposits, trading fees, transaction fees.
Here are a few popular ones:
- Zerodha Kite
Buying Mutual Funds:
- Zerodha Coin
A FEW IN-DEPTH TERMS:
Bull and Bear Markets:
Unless you’ve been entirely unaware of the stock market headlines and the viral tweets on the internet, the terms bull and bear should sound familiar. The names come from the way the animals attack their opponents. A bull raises its horns while a bear lowers its paws. These actions are metaphors for market movement—a bull market occurs when stock prices trend upwards, and a bear market occurs when stock prices trend downwards.
Market cap is a way of expressing the total value of a company. So, if the price of one share is intended to represent one slice of the total worth, then the market share price multiplied by the total number of public shares issued represents the total worth or the market cap of that company. It is a useful tool to compare two companies because you can’t compare the size of companies based on share price alone.
If company A has 100 shares issued and they cost Rs 100 per share, that company has a market cap of Rs 10,000. On the other hand, company B has shares that only cost Rs 10, but it has 1,00,000 shares issued for a market cap of Rs 10,00,000. However, if you were to compare based on share price alone, you would assume that company A is more extensive.
Return on Investment (ROI):
Return on Investment (ROI) is a metric used to analyse the profitability of a single or several investments. It evaluates the amount of profit made on a given investment with reference to its cost.
Return on Assets (ROA):
Return on Assets (ROA) is a metric that measures how well a company generates money from its assets. The Return on Assets (ROA) tells a manager, investor, or analyst how effectively a company’s management utilises its assets to generate lucrative earnings.
Return on Assets (ROA) = (Net Income/ Total Assets) x 100
Earnings per share (EPS):
Earnings per share (EPS) is a widely used indicator for measuring corporate value. It shows how much money a firm produces for each share of its stock. Earnings per share (EPS) is calculated by dividing a company’s net profit by the number of outstanding common shares (the shares you buy). Consequently, investors will shell in more money for a company’s shares if they believe its profits are higher than its share price. So, a higher EPS signals more value.
EPS = Net Profit / Common Shares
Return on Equity (ROE):
Return on Equity (ROE) is a metric that assesses a company’s profitability in terms of stockholders’ equity. It is a financial performance indicator computed by dividing net income by shareholders’ equity. Thus, it can be referred to as the return of net assets.
Price to Earnings ratio (P/E):
The price-to-earnings ratio is the ratio of a company’s share price to its earnings per share. It provides an idea about how much the investors are ready to pay for one unit of its earnings. The ratio is used to assess the worth of a company; whether it is overvalued or undervalued, a lower P/E ratio implies that they are undervalued stocks and might have the potential to grow.
P/E = Market price / Earnings per share
The ratio of Debt to Equity (D/E):
The debt-to-equity ratio measures how much total debt and financial liabilities weigh against total shareholder equity for a company. In simple words, the debt to equity ratio is what it owes on unpaid debts and equity. Thus, a high debt-to-equity ratio indicates that the firm is massively in debt.
The ratio of Working Capital:
The money you need to fund short-term operations is known as “Working Capital.” It assesses the company’s financial health and is imperative since it demonstrates the company’s liquidity. Liquidity is essentially the ability to buy and sell quickly.
A low working capital might be a bad sign as it indicates that they have a negative cash flow and cannot cover its debts. A high working capital is not necessarily a good thing either since it can indicate that the company is letting the excess cash flow sit idle and is not reinvesting it in their growth.
Working Capital = Current Assets – Current Liabilities
Graph analysis helps in assessing the price of a stock. Here are a few terms that you should know as an investor.
Candlesticks: A candlestick is a form of technical analysis price chart that shows the high, low, open, and closing prices of securities over time.
Candlestick as a technical analysis price chart
Trendlines: Trendlines are lines drawn on charts to connect a series of prices. The resulting line gives a good idea of how the prices will move in the near future.
Support Line: A support line determines a minimum price level through which the asset is unlikely to pass. It exists below the current market price and shows the lower limit of the stock price.
Resistance Line: The resistance line is a price point where the cost of stock is unlikely to reach. It is always above the current market price, and shows the upper limit of the stock price.
Moving Average trendlines: A moving average trendline smooths out data volatility, making it easier to see a pattern or trend. The trendline averages a certain amount of data points and uses the average value as a trendline point. Hence, it helps in leaving out extreme fluctuations and presents a more realistic and long term movement.
A COMPARISON BETWEEN BONDS, MUTUAL FUNDS AND DIRECT EQUITY
More often than not, the risk factor associated is directly proportional to the returns that you get in the market.
Bonds are the least risk (and hence least return) entities, something our parents/grandparents would have been interested in. A bond is a loan taken by a company, but the twist lies here—instead of going to a bank, the company gets the money from investors who buy their bonds, and in return, the company pays interest to the investor. Bonds can be classified into corporate bonds, municipal bonds, and gold bonds.
A mutual fund is essentially a pool of money collected from different investors and using that money to make large investments. An Asset Management Company (AMC) manages them. Mutual funds can invest in bonds and equities, or even a mix of both, and the risk factor involved is also between the two.
Mutual funds are classified into three types depending upon the market cap of the companies in the pool. This is done in increasing order of risk and return.
- Large Cap
- Mid Cap
- Multi Cap
- Contra Value
- Small Cap
- Thematic Funds
This is when you directly buy shares from the company. Investing directly in equity can be rewarding for those who have adequate knowledge about the market. However, with huge gains, equity also brings many risks if not taken care of properly. You are essentially directly investing in the company’s future. It is classified into three types depending upon the market cap of the company:
- Large Cap
- Mid Cap
- Small Cap
(Data is the average returns over three years)
(Data is the average of returns of top ten mutual funds over one year)
FACTORS AFFECTING THE PRICE OF A STOCK
The price of a stock is affected by a lot of factors. An aware investor is always on the lookout for signals that can impact the market.
- The ratios and terms mentioned above, working in conjunction with the demand and supply of the market.
- Future plans of the company: A company can grow only when it has a solid plan for the future, and shareholders are looking out for such signals. As a result, the share prices rise if the plans are concrete enough. For example, Airtel announcing their plans to implement 5G, or Tata Motors announcing their electric division, drove up the respective companies’ share prices.
- Market Sentiment: it is the general outlook of the investors towards a particular stock or the overall financial market. Generally, sentiment drives the demand and supply, which in turn leads to the movement in prices.
Shareholders influence how companies behave, promote investment, and decide the companies they want to invest in. Its growing power and influence in the way our economies work make it a subject of interest. Raising cash allows companies to expand their operations, grow their businesses, and create jobs in the economy. This investment is critical for economic growth, prosperity, and commerce.
MoneyControl.com. Investopedia, Wikipedia
Written by Divyansh Kulshreshtha and Aditya Naik for MTTN
Edited by Suhani Kabra for MTTN
Featured image via Pixabay
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