Although it’s easy to forget sometimes, a share is not a lottery ticket… it’s part-ownership of a business. – Warren Buffett
In this article
What is equity (or commonly known as share)? What are shares and stocks? Most people think that it is a number that keeps changing everyday. In reality, a share is nothing but a part ownership of the company. In other words, if you own a share of a company, you own a tiny part of the company.
You may have heard about Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). These are nothing but markets where shares can be bought or sold. Like most markets, these stock markets only allow certain groups, called brokers, to buy and sell shares. If you and I have to buy and sell shares, we have to go through a broker.
Like any other market, price of a share depends on many factors. In the short term, it depends on demand and supply on that day. If everybody wants to buy shares of a company and if there are very few sellers, then the price of the share will increase. On the other hand, if everyone wants to sell their share of a company and nobody wants to buy, then price goes down. In some sense, the short-term share price of company depends on what the market thinks about the fortunes of that company. If everyone thinks positive about the company, then price may rise. Similarly, if investors are pessimistic about a company, prices may fall.
In the longer term, the share price of a company depends on the fundamental factors like management quality, profitability and its growth, market share, industry outlook, economic outlook and so on. If a company does well, it’s share price will also do well in the long term.
Market capitalization is another word for company’s total worth. It is same as total number of shares multiplied by price of each share. Theoretically, if you want to buy a whole company, you have to pay market cap of that company.
Return on investment
When you invest in shares, you can get two types of return – Capital gain/loss and dividends.
Capital gain (or share profit/loss) – If you sell the share for price higher than what you bought, you can make capital gain or profit. On the other hand, if you sell for a lower price, you will incur capital loss. There is tax implication on the capital gain depending upon the holding period. If you sell within a year of purchase, you will have to pay short-term capital gains (STCG). STCG was 15% for the year 2015-16. If you sell after one year of purchase, you will have to pay long-term capital gains (LTCG). The LTCG was 0% for the year 2015-16.
Dividend – The company may distribute the profit earned to its shareholders. This is called dividend.
How to invest
Though the shares of the company are traded on the stock exchange, a retail investor cannot just go to a stock exchange website/office and buy/sell shares. One can invest in shares only through a broker or sub-broker, registered with SEBI. To invest the investor should also have a demat account. The investor’s stocks are held in an electronic form in his/her demat account. Usually the brokers or sub-brokers help to the investor in opening a demat account. In addition, an investor must have a valid PAN number.
An investor must study the economy, market, industry, company and its competitors before making the investment decision. Since most of the retail investors are unable to do such an in-depth analysis, they rely on advice of financial experts or portals. Once decided, the order can be placed through a broker (online or offline) for the equity investor is interested to invest in.
You can also invest indirectly in stocks through mutual funds. In a mutual fund, you give your money to a professional fund manager, who does a detailed analysis and invests on your behalf in stocks.
Returns and Risk
Equity investment is considered one of the most risky investments. Since the price of the equity depends on many micro and macro factors, it is highly unpredictable in the short term. Below is the risk-return comparison of various investment products. Detailed definition of other instruments can be found in other articles on groww.in.
Type of equities
Equities can be classified in many ways. The most popular one is based on the market capitalization of the company.
Large Cap – Large companies with market cap of more than 4000 crore are considered large cap. The share price of such companies are less volatile as compare to mid-cap and small-cap. Investment in large-cap stocks typically gives higher dividend income as compared to mid and small cap too. Since these companies are well-known, capital gains for shares of such companies will be similar to that of overall stock market.
Mid Cap – Shares of the mid-sized companies with market-cap between 250 cr to 4000 cr are considered mid cap. These companies are reasonably well-known and expected to have good growth potential. The stocks are relatively more volatile than large-cap and are a lot more sensitive to market news.
Small Cap – These are small companies with market cap of less than 250 cr. They are highly risky and may lack liquidity in the market. As these companies are small, they also have potential to grow a lot. As a result, the capital gain on these stocks can beat the ones of large cap or mid cap investments.
These classifications are approximations that change over time and can vary between brokerage houses.
In this blog, you have hopefully learnt the basics of investing in shares and gained an understanding of various terms and jargons related to stock-market investing. Feel free to comment with any questions or clarifications you are seeking.