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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.

56097 views  23 Oct 2017

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

    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