Investing refers to the process of allocating your money towards an asset with the expectation of financial gains in the future. These financial goals can range from purchasing a house to funding a child’s education to securing financial stability post-retirement.
Numerous investment options are available, each with its unique goal, associated risks, and potential returns. This tutorial focuses on one popular form of investment in India – stocks. Let’s dive into the basics of the stock market.
Stocks, also known as ‘equities,’ represent ownership shares in a company. The price of each share is derived from the overall value of the company. Therefore, when you purchase a company’s shares, you essentially own a small part of that corporation.
Consider an instance where an individual named Rahul seeks to start a company but lacks sufficient funds. He invites two friends to invest, offering them 30% ownership of the company in return. After 5 years, the company performs well and sees its value quintuple. Consequently, the investment made by Rahul and his friends also increases by five times.
However, it’s crucial to note that not every company’s shares can be bought. For outsiders to purchase a company’s shares, the company must be publicly listed on the stock market.
The Stock Market: A Primer
The stock market serves as a platform for trading company shares. It brings together buyers and sellers of different companies’ shares. Moreover, it provides information about the liquidity an investor might require after purchasing a company’s shares.
In India, two national-level stock exchanges exist: the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Private companies transform into public companies when they list their shares on these stock exchanges, allowing anyone to buy or sell their shares.
Why Do Companies List Their Shares on Stock Exchanges?
Companies primarily list their shares to raise capital. The funds procured from selling shares can be utilized in various ways, such as launching a new product, expanding facilities, or entering a new market.
Working on the Stock Market
The stock market is a trading platform for stock traders. When an investor wishes to buy stocks of a publicly-listed company from a stockholder, the transactions are conducted on the stock exchange. The exchange matches potential buyers with sellers and charges a commission fee for conducting the trade.
Types of Stock Markets
Understanding the stock market requires knowing its two types: the primary and secondary stock market.
- Primary Stock Market: When a company decides to go public, it first issues shares through an Initial Public Offering (IPO). This IPO is managed by an underwriter who handles all legal formalities, determines the appropriate share price, and identifies the right time for the issue based on market demand.
- Secondary Stock Market: After the IPO, if shareholders want to sell their shares, they do so in the secondary market. The sellers and buyers place their bids and conduct transactions. This process enables the shareholders to liquidate their shares.
Investing in the Stock Market
Here are the steps to invest in the stock market:
- Choose an Intermediary (Broker): A broker, authorized by the Security and Exchange Board of India (SEBI), acts as an intermediary and trades shares on your behalf on the stock exchange. They charge a fee for their services.
- Open a Demat Account: A Demat account holds shares and securities in an electronic format. The process to open a Demat account involves visiting your broker’s website, filling out an application form, scanning and submitting required documents, and providing bank account details for transactions.
- Buy Shares: Once your Demat account is set up, you can instruct your broker to buy or sell shares for you.
How to Choose a Stock?
The choice of stock to invest in requires careful consideration.
Here are a few criteria you may want to consider:
- Understand the Company: Look at what the company does, its products or services, and its growth potential. A good understanding of the company can help you predict its performance in the future.
- Financial Health: Study the company’s balance sheet, income statement, and cash flow statement. Look for profitability, low debt levels, and steady cash flows.
- Company Management: Assess the leadership of the company. Effective, ethical, and experienced management is a key ingredient to the success of any company.
- Industry Performance: Analyze the industry’s future prospects in which the company operates. Some sectors do well in a growing economy, while others can withstand economic downturns.
- Price-to-Earnings Ratio (P/E): This is a valuation ratio of a company’s current share price compared to its per-share earnings. A high P/E ratio could mean that a company’s stock is over-valued, or else that investors are expecting high growth rates in the future.
- Dividend Yield: If you’re interested in regular income, consider the company’s dividend yield. This is the dividend per share that the company pays out to its shareholders each year divided by its share price.
Risks Associated with Stock Market Investing
While investing in the stock market can provide substantial returns, it is not without risk. Prices of stocks can fluctuate wildly due to factors like market sentiment, economic indicators, political instability, company news, and so on. Therefore, it’s crucial to diversify your investment portfolio to spread the risk and not invest money that you cannot afford to lose.
It’s also worth noting that investing in stocks requires time, patience, and the ability to keep emotions at bay, especially during market downturns. Instead of panicking and selling stocks when prices fall, successful investors use these opportunities to buy high-quality stocks at lower prices.
Investing in the stock market can be an excellent avenue for growing wealth over the long term. By understanding the fundamentals of the stock market and investing in quality stocks, you can work towards achieving your financial goals. However, given the inherent risk associated with stocks, it’s advisable to consult with a financial advisor or undertake adequate research before making investment decisions.
CurrencyVeda provides educational content designed to enhance financial knowledge and does not offer financial advice. The information shared should not be construed as financial advice or a recommendation to buy or sell any type of securities or investment products. Always consult with a qualified professional before making any financial decisions.
As of 2021, India has over 20 million active stock investors, a number that continues to rise.
Approximately 4% of India's population, roughly 60 million people, are investing in the stock market.
India's stock market, comprising of BSE and NSE, is vast with over 5000 publicly listed companies.
Yes, investing in stocks can offer good returns over the long term, but it carries risk.
Online resources, books, finance courses, and financial advisors are effective ways to learn about stock market investing.