A journey into Stock Market
In this edition, we will explain the nuances of equity market and what a beginner must do to get started with their stock market investments.
The Basics of Investing in Stock Market
Creating wealth is everyone's dream and the aspiration of making money often brings people to the stock market. However, you need to be careful while investing in the stock market and realize that patience is needed to create wealth in long term. You also need to understand that like any other profession, investing in the stock market requires skills, subject knowledge, risk-taking capability and time.
Here is a quick tutorial to help you understand the basics of investing in the stock market:
- All that glitters is not gold
Capital appreciation is the key reason to invest in the stock market. But not all stocks are going to create wealth for you, even in long term. Take for instance the below mentioned stocks:
Stocks 10 years return (CAGR) Value of Rs 1 lakh invested 10 years ago Wealth Creators Eicher Motors 57% Rs 92,03,559 Bajaj Finance 49% Rs 54,19,041 MRF 33% Rs 16,73,886 No Wealth Creators ONGC 1% Rs 1,14,585 Tata Steel 1% Rs 1,08,941 Karnataka Bank 0% Rs 98,809 Wealth Destroyers BHEL -10% Rs 36,088 DLF -12% Rs 29,099 Suzlon Energy -24% Rs 6,224
Returns as on September 14, 2017
The above table clearly shows that all stocks do not create wealth for investors; some can destroy wealth as well. An interesting thing to note about the table above is that well known stocks have destroyed investors' wealth. So, all that glitters is not gold. Though wealth creation is the primary motive, proper research is necessary for positive outcomes.
- Wealth Creation in Long Term
To create wealth in the stock market, you should consider investing for a longer duration. Capital appreciation can be achieved through long term investment even though there are short-term volatilities.
Take a look at the below chart that describes the growth of companies in a span of 10 years despite various ups and downs.
The above chart clearly shows that Bajaj finance, MRF and Eicher motors were trading at low prices in 2007 and appreciated significantly in a span of 10 years despite various ups and downs.
- Higher CMP does not make the stock expensive
Generally, investors have the tendency to believe that the higher the stock price, the more expensive is its valuation. But it's not true, the value of a stock is best calculated in terms of its valuation multiples like PE Ratio. PE ratio is one of the predominant valuation multiple used by the analysts and investors to value a stock. Its calculation is shown below:
For instance, take the case of leading tyre manufacturers MRF and CEAT. On comparing their PE ratios, it can be observed that both these stocks are valued almost equally. So the CMP doesn't make a difference in this case.
High CMP does not mean stock is expensive:
Company CMP Trailing PE MRF Ltd. Rs 64,430 25.4 Ceat Ltd. Rs 1,735 24.4
Thus, it can be inferred that a higher stock price doesn't make the investment costly.
Liquidity of a stock is a key parameter of investing in a stock. It does not make any sense to own a stock if you cannot sell it when you require funds. Besides, stocks with low liquidity also have high impact costs. So before you take a call on the basis of other critical investment factors, ensure that you consider liquidity of the stock.
Apart from the aforementioned points, here is a step-by-step guide on investing in the stock market:
7 step guide of investments in Stock Markets-
- Understand the business
- Look for long-term investments
- Diversify your investments
- Do thorough research before short listing the stocks
- Check the financials of the company
- Check the company for competitive advantage
- Verify the credibility of management
Things to watch out for:
- Frequent capital raising in spite of profits
- Zero tax for extended periods
- Significant increase in inventory or debtors
- Capex beyond industry comparables
Mr Aniruddha Dange is the Chief Strategy Officer at IIFL group with focus on process optimization and digitization. Previously, he served as the Head of Research, Institutional Equities at India Infoline Ltd. Mr. Dange was also employed at RBS Research, CLSA Limited and ICICI Securities Ltd. Mr Dange is an Alumnus of IIT Bombay and IIM Kolkata and has over two decades of experience.
Ask an Expert
What is equity?
Equity represents ownership in a company acquired through contribution of capital, which is required to set up or run a business. This capital is raised through issue of shares to the public or a group of private persons, where each share represents a proportion of the stake on the assets and profits of the company. These shares are either bought directly from the company through an offer, or traded (bought and sold) on the stock exchanges. The holder of shares has voting rights in the company, and enjoys dividends.
How to pick a stock?
By keeping track of stocks and analyzing them, you can spot and cash-in on opportunities as they emerge. Selection should be based on the advice of advisory service such as IIFL, research brokers, or analysts. When picking a stock by yourself, you should consider the company's fundamentals, past performance and future outlook. Also the investor needs to keep an eye on the market sentiment while picking a stock.
What factors determine the price of a stock?
There are number of factors that impact the price of a stock. The factors determining the price of a stock include demand and supply, and the fundamentals of the company including its growth potential.
- Demand and Supply: These include the number of stocks available for buying from the sellers; if buyers are more, the stock price appreciates and vice versa.
- Growth potential: The stocks prices of the companies also move on the growth potential of the companies. If companies have potential for growth, then their stock prices rises.
- Fundamentals: The nature of business, its management, and business prospects determine the value of stocks.
What is the best time to buy/sell stocks to maximize profits?
The basic rule in the market is to buy at a low price and sell at a high price to earn profits. However, many investors commit the folly of investing in overvalued stocks or stocks that have surged in price. Instead you should aim at choosing stocks that have decent fundamentals and those that promise a good run. Going with the market trend may be uncertain, so it is essential to study the fundamentals, historical performance and trends before buying.
What is taxation on capital gains from equity investments?
Short-term gains from equity investment attract capital gains tax. If an investor gains from selling equity shares that were bought and sold in less than one year, he is liable to pay short-term capital gain tax of 15%, irrespective of the tax slabs. Long term gains are not taxable. Gains are considered long term if the holding period is more than 1 year.
How dividends are taxed from stocks?
Dividends received from Indian companies are tax free in the hands of the investors since the dividend distribution tax is already deducted before paying dividends. However, if the aggregate dividend exceeds Rs 10 lakh then investors have to pay 10% tax on the dividend income above Rs 10 lakh. For example, if an investor has received Rs 15 lakh dividend then he has to pay Rs 50,000 (Rs 5 lakh x 10%) as tax.
What is Dividend?
Dividend is the part of profit distributed by the company among its investors. It is usually declared as a percentage of the paid-up value or face value of the share.
What is a Bonus Share?
A share issued by companies to their shareholders free of cost due to capitalization of accumulated reserves from the profits earned.
What is taking a position?
When you are buying or selling a stock, you are taking a position. There are two kinds of positions: When you buy stocks with an intention of selling it at higher profits, you are taking a long position. Short positions involve selling stocks and buying them at a lower price to earn profits.
What is an Index?
An Index is termed as a stock-market indicator that is a statistical measure of the performance of an entire market or segment of a market based on a set of securities from the market. It is used to evaluate performance of certain market segment or set of stocks as it taps aggregate market movements.
What do you mean by Market Trades and Off Market Trades?
Any trade that is settled through a clearing corporation is termed as a 'Market Trade'. These trades are done via brokers on a stock exchange. 'Off Market Trade' is settled directly between two parties without the involvement of a clearing corporation.