Know the basic terms and concepts related to investing in equity
If you are a newbie who is enthusiastic to invest in the Indian Stock Markets but do not know much about them then this article will enlighten you and answer some of your basic questions about investing in them.
Why should you invest in stock markets?
Many of the traditional methods of investing like bank deposits don’t earn you much return that will enable you to beat inflation. Equity investments have the potential to give you higher returns.
What are equity stocks?
In simple words they represent ownership for that share or part of the company. Thus, they should not be seen as mere instruments with a buy and sell price but as businesses having assets, sales, profits etc. and the potential of a share as representing the value of that business.
Are they too risky?
The answer to this depends on you. If you buy stocks based on what you randomly heard or on the whims and fancies of others then you are not investing but merely gambling. However if you pick stocks after carefully evaluating certain parameters like their financial position, past track records and future growth potential rather than mere speculation then you can lower the risks associated with the investment as the stock of a company which is doing well, should also do well whether the markets realize it in the short run or eventually in the long run.
What do I need to start investing?
You need to open a Demat Account with NSDL which you can open through any of the stock brokers or some Banks. Once your account opening formalities are over you can start transacting. There are generally two types of transactions in the cash segment. One is intraday trading where you buy and sell on the same day. The other is delivery based trading where you buy a stock and take delivery on that day. The NSE and BSE are the two leading exchanges in which we generally trade in stocks. For these exchanges it takes 2 days for our delivery based trade to settle. This means that if we buy shares on delivery basis on Tuesday we can sell them only on or after Thursday. Also the transaction fees or brokerage, which is a small percentage of our transaction value that is charged by the brokerage firm, is higher for delivery based transactions than intraday transactions. After your transactions are done you get a contract note that contains all the details of your transaction like the scrip purchased, the rate and quantity, the brokerage, Securities Transaction Tax and other taxes charged. Transactions can also be done in Futures and Options (F & O) segment which is out of scope for this article.
Some terms associated with investing in stocks
You will come across these common terms once you start tracking your stocks and following market news and discussions.
Blue chips – These are stocks of big reputed companies.
Bottom Fishing – During bearish phases when share prices are down, investor’s strategize to buy undervalued stocks at lower prices with an anticipation that they will recover and adjust to their fair value in time. However, this may be risky as prices are down for a reason and may not bounce back. On the other hand it could also be an opportunistic move if the stocks are properly researched and the investor has reasons to believe that the fundamentals are good and the price is down due to temporary circumstances.
Bulls and Bears – Bulls relate to group of investors who are optimistic and think markets will go up in the long run while bears relate to those who think share prices are going to go down.
Benchmark Index – A benchmark is a standard to which we compare performances of individual stocks. An Index is an imaginary portfolio of securities representing a particular market expressed in terms of change from a base value. In India the most common benchmark indices are SENSEX and NIFTY 50. SENSEX is a stock market index of top 30 blue chip companies listed in the Bombay Stock Exchange (BSE). Similarly NIFTY 50 represents top 50 companies listed in the National Stock Exchange (NSE). These indices generally reflect the free-float market capitalization of their constituent shares with respect to a base. Free-float market capitalization excludes promoter’s holdings and others that are not readily tradable in the exchanges from the total market capitalization. Examples of some of the other indices in India are BSE 100, S&P CNX 500, Nifty Bank etc.
Beta – This statistical parameter shows how volatile a particular stock is, when compared to the markets. For example, if a stock has beta 1.2 then it simply means that when markets move in any particular direction, the stock moves 20% more than the markets in the same direction. Similarly, a Beta of less than 1 indicates stock is less volatile than the markets. A Beta of 1 indicates the volatility of the stock is the same as that of the markets. A negative beta indicates that the stock moves in the direction opposite to that of the markets which is possible even though it is unlikely. If a stock has a high Beta, it means it is very volatile and for small increase in the benchmark indices, like SENSEX or Nifty 50, it is likely that there is a relatively large increase in the share price of that stock and vice versa. High beta stocks are riskier and can make you high profits as well as high losses.
FII’s and DII’s – FII’s (Foreign Institutional Investors) are big foreign institutions which invest in the Indian Markets. DII’s are domestic institutions such as Mutual funds and Insurance companies who also do bulk investing in the Indian equity markets.
Fundamental Analysis – It is the analysis of the financial health of a company i.e. analysis of its assets, liabilities, sales, profits, industry it operates in, etc in order to evaluate the company’s share value based on these fundamentals.
Growth Stocks – Stocks of those companies whose earnings are expected to grow at a rate much higher than the average industry growth rate are called growth stocks. These are generally stocks of small or midcap companies which have a high chance of becoming a large company in future based on fundamentals and trends.
Intrinsic Value – Intrinsic value of a share is the estimated fair value of the share of a company based on the company’s financial position and growth potential. There are a number of ways to calculate the intrinsic value of a share which will be discussed in other articles.
IPO – Initial Public Offering is public offering of newly issued shares of a company for the first time to the public in the primary market. Initial subscription to the IPO has to be done by retail investors in the prescribed format and not through normal secondary market transactions at the stock exchanges. After the IPO’s are subscribed they are listed in the exchanges and can then be traded in the secondary market i.e. the stock exchanges.
ISIN – The International Securities Identification Numbering is a twelve characters alphanumeric code unique to every stock and bond.
Margin of Safety (MOS) – When the estimated intrinsic or fair value of a share is higher than the share price at which it is currently trading in the stock exchange, the difference between the two prices provides the investor a safety cushion or margin of safety so that if they invest at these lower prices, there is less risk of a downside and higher probability that the shares will at least achieve their fair value in time. The diagram below will make it clear.
Market Capitalization – Market Cap for any stock is calculated as the number of shares outstanding multiplied by the market share price. Companies are referred to as Large cap, Mid cap or Small cap based on their market cap. Generally Large cap stocks are stocks of big well established companies where risks are less and growth is also less aggressive though there maybe exceptions. Mid caps and Small caps might have higher levels of risk but selective stocks also give higher returns and so one must be more cautious and select these stocks after due research.
Open Interest – Open interest is the total number of outstanding or open positions taken in the market. It applies more to the F & O segment which is outside the scope of this article, however knowing about it will help you understand what it indicates about market trends and direction which in turn will help you take better decisions for your investments. When open interest increases, it means that more people are entering into the markets and taking fresh positions which indicates that the current trend (up or down) should continue. When there is decline in the open interest levels in the market it signifies that more people are closing their positions and there might be a trend reversal.
Price to Earnings Ratio – P/E or price to earnings ratio is calculated as market price of a share ÷ earnings per share. It measures the number of times the price of a stock is per rupee that it earns in profit. For example, the P/E multiple of a stock is 12, then it simply means that it is trading at a price in the market which is 12 times its current earnings. P/E multiples can be used to value a share and find out if it is expensive (currently trading at higher price than its fair value) or attractive. Using this model of valuation you can find out the fair value of a stock by multiplying the industry average P/E ratio to the EPS (Earnings per share) of the company. The P/E multiples are also useful in determining whether markets are in the oversold value zone or overbought expensive zone by comparing their current P/E multiples with the average P/E multiples to see if they are comparatively lower or higher respectively.
Price to Book Value Multiple – The price to book ratio measures the market price of a share ÷ book value of a share. Please note that the book value does not only mean the face value of equity shares in the book but is adjusted to outflows like dividends and inflows like retained earnings. This multiple shows how many times the market price of the share is per book value of the share. Like the P/E multiple this multiple can also be used to find the valuation of a stock in a similar way.
QoQ and YoY results – All companies declare their quarterly financial results after every quarter, the quarters being Q1 (Quarter 1 – results for April to June – generally declared in July or August), Q2 (results for July to September), Q3 (October to December) and Q4 (January to March). Additionally annual results are also declared for the entire year after Q4. When these results are declared they are compared with the corresponding quarter or year in the previous year. For example if a company had Net Profit of 100 crores in Q3 of Financial Year 2015-2016 (FY 15) and 150 crores in Q3 of FY16 then we say that profits have increased by 50 crores or 50% QoQ (Quarter on quarter). Similarly YoY stands for year on year. These comparative results give us an indication regarding performance and growth of a company which in turn affect stock prices.
SEBI – SEBI (Securities and Exchange Board of India) has statutory authority to regulate the stock markets.
Sectoral or Industry Averages – Generally the business environment, the sales and profit drivers, cost structures of companies operating in a given sector are similar and it makes sense to compare the performance of a company based on the average performance (i.e. sales, margins or profits, financial ratios and multiples) of that sector or industry. The major sector categories with the perspective of Indian stock markets are Banking, Automotive, Pharmaceuticals, Information Technology, Telecommunications, Power and Infrastructure, Cement and Construction, Fast Moving Consumer Goods (FMCG), Oil and Gas, Aviation etc.
Short Covering – When traders short sell (in the cash or F&O segment), i.e. sell first to buy later as they think the share price is going to go down, but the share prices start showing upward trends instead, they buy back the stocks that have been sold short to avoid incurring losses from increasing prices. This process of buying back to cover their short positions is called short covering. When there is a lot of short covering you can expect a trend reversal and prices to go upwards.
Stop Loss – In simple words if you have purchased a share at Rs 500 and the share price is going down then you can set for yourself a stop loss at a lower price say, Rs 450 at which point you will sell the stock. This means that you have set yourself the maximum amount of loss that you are willing to bear and if prices go further down then you are just going to bail and not take risks below that level. This is done to minimize your loss.
Technical Analysis – Technical analysis involves analysis of past data of a company’s share price movements and volumes at various points of time with a view to determine the trend or direction in which the prices should move.
Value Stocks – Value stocks are those stocks that are currently undervalued, i.e. the current price they are trading at are much lower than their estimated fair values based on their fundamentals. The prices of these stocks are expected to go up and thus they are considered as value stocks having high probability to give profits with minimal risks.
This article only makes the new investors familiar with the above terms. To know more about how to pick a value stock, mistakes to avoid, when to sell it, how to calculate intrinsic value of a stock, fundamental and technical analysis of stocks and other such concepts read their detailed articles in the value investing section of this blog.
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