The stock market refers to the collection of markets and exchanges where the issuance and trading of equities or stocks of publicly held companies, bonds, and other classes of securities take place. A stock exchange facilitates trading in company stocks and other securities. A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting place of the stock buyers and sellers. There are four broad segments of stock market, viz, Equity, Derivative, Debt, &MF.
It is a market where financial instruments are issued & traded. Stock market facilitates mobilization of funds from those with excess of it (Investor) to those who are in need for funds (Business). Business owners raise fund from the market by way of issuing shares to investors.
Stock market is broadly divided into two; viz,
Primary market is the market where investors can buy shares directly from the issuer company. A company comes up with an Initial Public Offer (IPO) for raising fund from general public to meet its fund requirement. Investors are issued shares in proportion to their investment in the company. These shares are listed on the stock exchange to facilitate easier, speedier, & efficient transfer of shares. This whole process is called getting the company/shares listed on stock exchange.
Secondary Market is the market where stocks, which are issued to investors through IPO, are traded. Secondary market provides existing shareholders a platform where they can exit from their investment by selling shares in the market. Those investors desirous of buying shares of a company but couldn’t get in IPO can buy shares from secondary market. This buying and selling activity is carried out on screen-based trading platform of Stock Exchange facilitated by stock brokers.
Investors are broadly categorized as (i) Institutional Investors, & (ii) Non – Institutional Investors
Large organizations (such as banks, insurance companies, pension funds, finance companies, mutual fund) which have considerable fund to invest are referred to as Institutional Investors. Such investors originated within the country are called Domestic Institutional Investors (DII), and those located outside the country are known as Foreign Institutional Investors (FII).
Non – Institutional Investor is an individual investor. It includes Retail investors, High Net Worth (HNI) investors, & Corporates.
Capital markets functioning in India is regulated by Securities & Exchange Board of India (SEBI). Rules and regulations governing Indian securities market are framed, overhauled, & implemented by SEBI. The primary role of SEBI is to protect the interest of investors and to promote the growth and development of securities market in India so that, securities market continues to remain important source of raising fund. SEBI also works to ensure that Investors, Intermediaries, and Issuers carry out investing in orderly manner.
Markets are often described as ‘bull’ or ‘bear’ markets. These names have been derived from the manner in which the animals attack their opponents. A bull thrusts its horns up into the air, and a bear swipes its paws down. These actions are metaphors for the movement of a market. In bullish market prices continue to rise. If the trend is downward, it is considered as bearish market.
Equity refers to equity share which represents part ownership in a business. An investor can buy equity share of a company in return for price of a share and enjoys ownership right. Equity shareholders are owner of the company and are entitled to receive share in net profit of the company (i.e. Dividend). They wouldn’t get dividend if nothing remains after making paymentson debt obligation.
Equity is the most preferred investment vehicle for long term value creation. Although equity is the riskiest asset,ever since its existence It has proved to be delivering supernormal returns among all the asset classes.
We often make purchase or sell of various goods in our daily routine either for consumption or from investment objective. Likewise trading in shares take place when equity shares are bought and sold. Traders in shares are mainly aimed at making profits from trading in shares by purchasing at lower price and selling at a price higher than that. Buying and selling of shares is carried out on internet connected computer-based trading platform of stock exchange facilitated by stock brokers. Trading in financial instruments has now become easier and handy with trading applications installed in your smartphone. A stock trader may choose between intraday trade and delivery (or Positional trade).
It is an abbreviation used to identify shares of a stock of the company listed on stock exchange. It is also called Ticker. A symbol may consist of alphabets, numbers, or combination of both. It is time consuming and cumbersome to communicate and write full name of the company while trading in shares of stock of the company. For instance, you want to buy shares of “LARSEN & TOUBRO LTD”. While buying shares using trading application It’s completely unfeasible to write full name like this especially where prices fluctuate so rapidly. For, how about using just “LT” instead of full name “LARSEN & TOUBRO LTD”. That’s the symbol for the stock of the company.
Using tickermakes communication easier and trading activity faster. All the publicly listed companies are assigned a specific symbol. A company listed on two different stock exchanges may have different ticker on each stock exchange. For a company listed on both NSE & BSE,NSE ticker usually consists of Alphabets and BSE ticker is of 6 – digit Numeric. “LARSEN & TOUBRO LTD” can be searched on BSE using ticker "500510".
Intraday as the name suggests means trades must be settled within same day. To express differently, you have to square-off your trades on the same day. Squaring-off refers to you must sell what you have bought today or buy what you have sold today before the market close. It is also popularly known as Day Trading. Major driving force behind Intraday Trading are; low margin requirement, i.e., high leverage, and low brokerage.
Delivery buying as the term suggests, means that the securities which are not settled on Intra-day basis results into the Delivery. Client will have to make payment of shares bought by T+2 day (T refers to buying day) and the shares will also be credited to his Demat account by T+2 day.
Let us understand this with an example. Suppose a client enters a buy trade of 100 HDFC share@2000 per share. He needs to make a payment of Rs.2L by T+2 day and the shares received through payout from exchange on T+2 day shall be transferred to his Demat account on the same day.
Short sell refers to selling something which is not owned by you. In financial markets short sell means a person sell shares of a company which he doesn’t have. This is usually done from intraday trading perspective. The question may arise why would you short sell? Let’s answer it with an example. RELIANCE is trading at Rs.1200/- on a given day when quarter end result of the company is due. You may have a view that the company will post weaker financial performance, currently the stock is highly priced, and its price shall fall after the result. Here, you would seize the opportunity and sell RELIANCE at say Rs.1200/-. If the result is as per expectation and price falls you are at profit and vice-versa.
Therein lies the major risk of short selling, the fear of infinite losses. While the maximum loss for a long investor is the amount invested in a security, the maximum loss for a short seller is theoretically infinite, since there is no upper limit to a stock’s price appreciation.
There are thousands of companies listed on stock exchange. From among these stocks, some stocks are selected and grouped together to constitute an Index. Stock selection is done based on the various parameters like market capitalization, liquidity in market (no. of shares of company traded daily), listing history, etc. The values of the grouped stocks are used to calculate the value of the index. Any change in the price of the stocks leads to a change in the index value.
The question may arise, what is the use of Index? Investor sentiment is a very important aspect of stock market movements. This is because, if sentiment is positive, there will be demand for a stock. This will subsequently lead to a rise in prices. It is very difficult to gauge investor sentiment correctly. Indices help reflect investor’s mood – not just for the overall market, but even sector-wise and across company sizes.
NIFTY and SENSEX are key popular indices in Indian stock market. NIFTY is constituent of 50 stocks listed on NSE and SENSEX constitutes 30 BSE listed stocks. NSE and BSE follows stock selection methodology to include stock in the index and undertake periodic review of index constituents.
Some important global indices are; Dow jones, S&P 500, Nikkei, FTSE 100, Hang Seng.
Investing your hard-earned money without analyzing the investment alternatives is akin to jumping into water blind-folded. When talking about investment in equity, riskiest of all asset classes, it is imperative to analyze various aspects of stock market.
There are two approaches to stock market analysis, (i) Fundamental Analysis, (ii) Technical Analysis.
Fundamental analysis is the method of evaluating the intrinsic value of the share of a company. This method essentially aims to identify whether the share price of a company is fairly valued keeping in mind various forces such as financial performance, industry competitiveness, quality of management affecting share price of a company. All investment worth companies have some common attributes that sets them apart. Similarly, all wealth destructors have some common traits which can be seen by an astute investor. Fundamental Analysis is the technique that gives you the conviction to invest for a long term by helping you identify these attributes of wealth creating companies. Fundamental analysis is mainly composed of Company Analysis, Industry Analysis, & Economic Analysis.
Let’s dive into various concepts of fundamental analysis.
Book value of a company is the net worth of the company. Net worth is the amount of assets in excess of liabilities. The assets of the company are shown in the balance sheet at it’s book value (i.e. cost minus depreciation value) since it’s realizable value, which may be different from book value, is never known with certainty. To compute book value per share, net worth is divided by total no. of outstanding shares. In simple terms, BV per share means the theoretical amount of money each share would get in the event of winding up of the company.
The nominal price of a share is known as its face value. The equity capital of the company is calculated by multiplying the number of shares issued by its face value. Shares may be issued to the investors at the face value, or a price higher (premium) than the face value, or a price lower (discount) than the face value. The face value of share is important for calculating the dividend payable on a share. When dividends are mentioned as a percentage, that percentage is reckoned with regard to the face value.
The face value of a company’s share does not usually change unless the company decides to split or consolidate its shares. In such cases, the face value of company’s shares would reduce (in case of split) or increase (in case of consolidation).
Companies raise money from the market in accordance with their fund requirement. For, different companies issue varied amounts of shares and get them listed. The price per share may also be different from another company’s share price. It’s an arduous task to compare & classify companies based on this. Here market capitalization comes handy.
Market cap is arrived by multiplying the market price per share by total no. of shares of the company. It reflects the total market value of a company. For instance, if ONGC’s share is priced Rs.200/share and there are total 10 crore shares market, we can say at the given price and no. of shares, ONGC’s market cap stands at Rs.2000 crore. It keeps on changing with the change in market price of the share. Market cap matters the most while bucketing the stocks into different groups, such as Large Cap, Mid Cap, Small Cap. Market capitalization matters when stacking stocks into different indices.
Sales is the income which the company generates by selling its goods and services. From an analysis perspective, it is important to understand the contribution made by different segments, markets in company’s sales. Analyst’s and company’s keep close eye on sales growth, which help the company to determine whether there is a need for product diversification, market expansion, or new product launch. Sales growth must be analyzed to assess the contribution of increase in volume and/or increase in price. Applicable indirect taxes (GST) have to be deducted from gross sales to arrive at net sales amount. Sales figure is also referred to as “Top Line”.
Earnings Before Interest Tax Depreciation and Amortization (EBITDA)
This is the difference between Net Sales and Direct Costs. EBITDA is a measure of the operational efficiency of the company. It enables comparison between companies that may have different capital structures, depreciation policies and tax rates. Higher the EBITDA, better the firm.
Net profit is arrived after deducting depreciation, interest expenses, and direct taxes from EBITDA. PAT is the net income that belongs to equity shareholders. It is a measure of the profitability of a company after accounting for all the expenses and taxes. It is also referred to as “Bottom Line”.
Post-tax Profits in a business belong to the shareholders and a company can broadly do two things with those profits – retain them for investment in the business or return to the shareholders. If a company chooses to return money to all shareholders in equal proposition, it is said to have ‘declared a dividend’. A company may declare ‘interim dividends’ during the financial year and a ‘final dividend’ at the end of the year.
In practice, companies distribute part of the profits and retain part of the profits in the business. The proportion of distribution and retention of profits will primarily depend upon the opportunities available for ploughing back the profits into the business & ultimately availability of cash in the business. SEBI has mandated that listed companies shall declare dividends in rupees terms on per share basis as against the earlier practice of declaring dividends as a percentage of the face value to ease calculation.
Earnings per share is the net profit divided by the number of shares. It indicates the amount of profit that company has earned, for every share it has issued. A higher EPS shows higher profitability and better earnings for the shareholders and will be preferred over shares of companies with lower EPS. EPS is a significant variable in determining a share’s price.
One of the most significant aspects of fundamental analysis is Financial Ratio analysis. Right stock selection entails using some ratios to help you figure out the mettle of your investment. It is worth to note that a single financial ratio can never determine the true value of a stock. It is advisable to use a combination of ratios to get the bigger picture on the canvas about the financials of a company and the value of its stock. Some of the frequently used ratios are explained as under.
This is a ratio of EBITDA to net sales. EBITDA margin is presented in percentage terms. Absolute numbers make it impossible to compare two firms, however, when converted into percent, comparison can be done easily. Higher the EBITDA Margin, better the firm. It is measured in percentage terms.
It is ratio of net profit to net sales and presented in percentage terms. It represents how much profit each rupee of sales generates. It is one of the most sought-after measure while analyzing the financial performance of a company. A firm with a higher ratio is seen as more efficient in managing costs and earning profits. A trend of increasing margins means improving profitability. It is measured in percentage terms.
It is a ratio of Current Market Price (CMP) to EPS. PE Ratio measures the price that the market is willing to pay for the earnings of a company. PE is referred as a multiple of per rupee of earnings. It is common to look at the PE multiple of the index to gauge if the market is overvalued or undervalued. Usually, the PE multiple moves high in period of bull market and the market is willing to pay more and more per rupee of earnings. When markets correct and uncertainty about future earnings increases, the PE multiple also drops.
Analysts also compare the PE of one company with another, to check the relative value. The PE multiple of a stable, large and well-known company is likely to be higher than the PE multiple the market is willing to pay for another smaller, less known, and risky company in the same sector.
The P/B ratio measures whether a stock is over or undervalued by comparing the net assets of a company to the price of all the outstanding shares. This ratio shows the difference between the market value and the book value of a stock. The market value is the price investors are willing to pay for the stock based on expected future earnings. The book value, on the other hand, is derived from a company’s assets and is a more conservative measure of a company’s worth. Value investors often prefer companies with a market value less than its book value in hopes that the market perception turns out to be wrong.
It is the single most important & widely accepted parameter for an investor to analyze financial health of a company. ROE is calculated by net profit by net worth of a company. It is a measure of the profitability of a business in relation to its book value. It is also referred to as Return on Net-Worth (RoNW). ROE communicates how a business allocates its capital and generates return. An efficient business with better allocation of capital would have high ROE and a poor quality of business would have low ROE. It is a relative measure and represented in percentage terms. Higher the ROE, better the firm. ROE is measure in percentage terms.
This ratio measures how efficiently a company is deploying its capital to generate profit. It uses EBIT and calculates it as a percentage of the money employed in the firm by way of both equity and debt. EBIT is simply EBITDA minus depreciation and amortization. Capital employed is sum of total equity and total liabilities. Higher the ratio, better the firm since it is generating higher returns for every rupee of capital employed. Investors can use this to analyze the returns of companies with different sizes in the same industry. ROCE is measured in percentage terms.
The debt equity ratio shows the proportion of equity to debt that a company is using to finance its assets. When a company is using a lower amount of debt for financing it will have a low debt equity ratio. If the ratio is high it means that the company is financing more from debt relative to equity and this can pose a risk to the company as too much debt is not preferred. The debt-to-equity ratio can vary from industry to industry and depending on the type some companies have higher ratios than companies in other industries.
Unlike fundamental analysis, technical analysis has nothing to do with the financial performance of the underlying company. In this method, the analyst simply studies the trend in the share prices. The underlying assumption is that market prices are a function of the supply and demand for the stock, which, in turn, reflects the value of the company. This method also believes that historical price trends are an indication of the future performance. Technical Analyst use various charts and other technical indicators to make trading decisions. Technical analysts observe support and resistance levels to identify points on a chart where a pause or a reversal of the prevailing trend is likely to occur – to decide the entry and exit from a particular stock.
Technical analysis is often used by short-term investors and traders, and rarely by long-term investors, who prefer fundamental analysis. Instead of assessing the health of the company by relying on its financial statements, it relies upon market trends to predict how a security will perform. There are many technical analysis tools used across analyst’s community. Some popular technical analysis tools are Candle-Stick Chart patterns, Moving averages, Relative Strength Index (RSI), Super Trend, Stochastics, MACD, etc. Technical analysis is performed using specialized Software applications.
In financial market, Derivative refers to an instrument whose value is derived from the underlying asset. The underlying asset could be Equity share, Commodity, Currency, Interest Rate, Debt Instruments (like, Bonds, etc.). Derivatives on stock market indices (like NIFTY, BANKNIFTY) are also widely traded.
Derivatives are basically a bet on future value of the asset underlying derivative contracts. There are two types of Derivative instruments, Futures & Options (F&O). F&O are tools used by investors for speculation or hedging purpose. They offer the potential to earn huge profits besides posing risk of losing large amount.Let’s understand about it in detail.
It is an agreementbetween two parties to buy or sell the specified quantity of the underlying asset at an agreed price on a predetermined date. Here both the parties to contract are bound to fulfil their obligation, i.e., buyer has to buy the asset & make payment and seller must sell the asset.
Option grants the buyer of it the right but not the obligation. Option seller is bound to fulfil hisobligation if the buyer exercises his right. The price of the option is called “Premium”.Options can be used for hedging, taking a view on the future direction of the market, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions.There are two types of options. Call and Put.
gives the option buyer the right to buy the specified quantity of the underlying asset at an agreed price on a predetermined date. If Call buyer exercises his right Call seller has to deliver shares at agreed upon price.
gives the option buyer the right to sell the specified quantity of the underlying asset at an agreed price on a predetermined date. If Put buyer exercises his right Put seller has to purchase shares at agreed upon price.
As we have understood earlier that options areused for speculation and as a hedging tool, there is a variety of option trading strategies available to that end. Simple buy and sell of options gives the buyer the right to buy or sell the asset and creates obligation on option seller.
A trader may have bullish, bearish, or neutral view on the market. Accordingly, traders adopt various combinations of buying & selling call and put options to maximize profit in their trades. Such combinations are also used as a protective measure especially where stock prices are highly sensitive to news or events. Several popular option trading strategies are explained below.
Companies need money to undertake projects. Companies may approach banks or other landing institutions and take loan to fund projects. This borrowed money is repaid with interest to the bank. Similarly, a company can raise money from multiple investors in return for timely payment of interest, it is called Bond. Then the company pay back using the money earned through the project. Bond is a means of investing money by lending to others, that is why it is called debt instrument. There are debt instruments also like; Debentures, Commercial Papers, Certificates of Deposit, Government Securities (G-Sec), etc.
A bond is primarily characterized by its features such as; face value (i.e. amount of money borrowed), maturity of bond (i.e. when will the money borrowed be paid back), coupon rate (interest rate)