The Language of Stocks

 Anybody can make money in the stock market. By picking up the phone or turning on the computer, you can own a piece of a company—and all of its fortune or folly—without ever attending a board meeting, developing a product, or devising a marketing strategy.

• Why Stocks Are Good Investments

You should know why stocks are good investments before you start investing in them. There are two reasons to own stocks. First, because they allow you to own successful companies and, second, because they’ve been the best investments over time.

   

1.Stocks Allow You to Own Successful Companies

Just like you can have equity in your home, you can have equity in a company by owning its stock. That’s why stocks are sometimes called equities.Think of all the rich people you’ve read about. How did they get rich? Was it by lending money to relatives who never repay? No. Was it by winning the lottery? Not very often. Was it by inheriting money? In some cases, but it’s irrelevant because nobody has control over this factor. In most cases, rich people got rich by owning something.That something might have been real estate. You learned that land has value and that owning some is a good idea. In most cases, though, people get rich by owning a business.That’s why owning stocks is a good idea. They make you an owner of a company. Not an employee or a lender, an owner. When a company prospers, so do its owners.

2. Stocks Have Been the Best Investments over Time

That’s cute, you’re thinking, but does it really work that way? Let’s take a look at history and a few hard numbers.

The stock market has returned about 10.5 percent a year for the past 75 years or so. Corporate bonds returned 4.5 percent,Treasuries returned 3.3 percent, and inflation grew at 3.3 percent. Notice that Treasuries and inflation ran neck and neck? That means your investment in Treasuries returned nothing to you after inflation. When you include the drain of taxes, you lost money by investing in Treasuries. You need stocks. Everybody who intends to be around longer than ten years needs to invest in stocks. That’s where the money is. Investing in stocks helps both the investor and the company. 

• How Stocks Trade

When stocks are bought and sold, it’s called trading. So a person might say “IBM is trading at Rs 140.” That means if you wanted to buy IBM stock, you’d pay Rs 140 for one share.

Every company has a ticker symbol, which is the unique code used to identify its stock. In articles and reports, the ticker symbol is usually shown in parentheses after the first instance of the company name. For example, Google (GOOG), Harley-Davidson (HOG), IBM (IBM), and Toyota (TM).A Rs 1 move in stock price is called a point. If IBM goes from Rs 140 to Rs 143, you’d say that it rose three points. In the real world, IBM doesn’t usually trade in such clean increments as Rs 140 and Rs 143. Instead it would trade for, say, Rs 143.38.Some investors purchase shares of stock in blocks of 100. A block of 100 shares is called a round lot. Round lots provide a convenient way to track your stock investments because for every round lot you own, a one point move up or down adds or subtracts Rs 100 from the value of your investment. If you own 100 shares of IBM at Rs 143, it’s worth Rs 14,300. If it rises two points to Rs 145, your investment is worth Rs 200 more for a total of Rs 14,500.

• Preferred Stock vs. Common Stock

There are two types of stock, preferred and common. Both represent ownership in a company. Preferred stock has a set dividend that does not fluctuate based on how well the company is performing. Preferred stockholders receive their dividends before common stockholders. Finally, preferred stockholders are paid first if the company fails and is liquidated.Common stock is what most of us own. That’s what you get when you place a standard order for some number of shares. Common stock entitles you to voting rights and any dividends that the company decides to pay. The dividends will fluctuate with the company’s success or failure.

• How You Make Money Owning Stocks

This is really the bottom line to investors. The only reason you own a business is to profit from it. The way you profit by owning stocks is through capital appreciation and dividends.

Source: Google Images

1. Through Capital Appreciation

Sometimes called capital gains, capital appreciation is the profit you keep after you buy a stock and sell it at a higher price. Buy low, sell high is a common investment technique but it is just as legitimate to buy high, sell higher.

Expressed as a percentage, between your purchase price and your sell price is your return. For example, if you buy a stock at Rs 30 and sell it later for Rs 60, your return is 100 percent. Sell it later for Rs 90 and your return is 200 percent. The goal is appreciation, but sometimes investors end up with depreciation by mistake. If you bought Citigroup in November 2007 at Rs 35 and sold it in November 2008 at Rs 6, your return was -83 percent.

2. Through Dividends

As an owner of a company, you might share in the company’s profits in the form of a stock dividend taken from company earnings. Companies report earnings every quarter and determine whether to pay a dividend. If earnings are low or the company loses money, dividends are usually the first thing to get cut. On a declaration date in each quarter, the company decides what the dividend payout will be.To receive a dividend, you must own the stock by the ex-dividend date, which is four business days before the company looks at the list of shareholders to see who gets the dividend. The day the company actually looks at the list of shareholders is called the record date.If you own the stock by the ex-dividend date, and are therefore on the list of shareholders by the record date, you get a dividend check. The company decides how much the dividend will be per share, multiplies the number of shares you own by the dividend, and deposits the total amount into your brokerage account. If you own 10,000 shares and the dividend is Rs 0.35, the company will deposit  Rs 3,500 on the payment date.Most publications report a company’s annual dividend, not the quarterly. The company that just paid you a Rs 0.35 per share quarterly dividend would be listed in most publications as having a dividend of Rs 1.40. That’s just the Rs 0.35 quarterly dividend multiplied by the four quarters in the year.

3. Total Return

The money you make from a stock’s capital appreciation combined with the money you make from the stock’s dividend is your total return. Just add the rise in the stock price to the dividends you received, then divide by the stock’s purchase price.For instance, let’s say you bought IBM at Rs 45 and sold it two years later at Rs 110. IBM paid an annual dividend of Rs 1.00 the first year and Rs 1.40 the second year. The rise in the stock’s price was Rs 65, and the total dividend paid per share was Rs 2.40. Add those to get Rs 67.40. Divide that by the stock’s purchase price of Rs 45 and you get 1.5, or 150 percent total return.

4. Stock Split

A stock split occurs when a company increases the number of its stock shares outstanding without increasing shareholders’ equity. To you as an investor, that means you’ll own a different number of shares but they’ll add up to the same

amount of money. A common stock split is 2-for-1. Say you own 100 shares of a stock trading at Rs 180. Your account is worth Rs 18,000. If the stock splits 2-for-1 you will own 200 shares that trade at Rs 90. Your account is still worth Rs 18,000.Companies split their stock to make it affordable to more investors. Many people would shy away from a Rs 180 stock, but would consider a Rs 90 one. Perhaps that’s still too expensive. The company could approve a 4-for-1 split and take the Rs 180 stock down to Rs 45. Your 100 shares would become 400 shares, but would still be worth Rs 18,000. People considering the stock might be more likely to buy at Rs 45 than at Rs 180, even though they’re getting the same amount of ownership in the company for each dollar they invest. It’s a psychological thing ! 

       Mathematically, stock splits are completely irrelevant to investors but they are often a sign of good things to come. A company usually won’t split its stock unless it’s optimistic about the future. Think about it. Would you cut your stock price in half or more if the market was about to do the same? Of course not. Headlines would declare the end of your fortunes and lawsuits might pile up. Stock splits tend to happen when a company has done well, driven up the price of its stock, expects to continue doing well, drops the price of its stock through a split, and expects to keep driving up the stock price after the split.

         Stock splits were everyday occurrences in the 1990s bull market. IBM split twice, Oracle split five times, Microsoft split seven times, and Cisco split eight times. A $10,000 investment in Microsoft in January 1990 was worth about $900,000 in January 2000. The stock didn’t just run straight up 90-fold, however. It made five 2-for-1 splits and two 3-for-2 splits along the way. It rose and split,  until  $10 grand turned into $900 grand. You can be sure that Microsoft wouldn’t have been splitting its stock if it wasn’t excited about its future.

           Remember that a stock split drops the price of the stock. Lower prices tend to move quicker than higher prices. Also, the fluctuations of a lower priced stock have a greater percentage impact on return than they do against higher priced stocks. A Rs 2 increase is a 4 percent gain for a Rs 50 stock, but only a 2 percent gain for a Rs 100 stock.

     More important than all this, however, is that splits are downright fun. You’ll love it when your 100 shares become 200 and every Rs 1 gain in price puts Rs 200 in your pocket instead of the previous Rs 100. You’ll feel like a real pro when revealing your performance to friends and need to toss in the phrase “split adjusted” at the end.

• Why and How a Company Sells Stock

Companies want you to buy their stock so they can use your money to get new equipment, develop better products, and expand their operations. Your investment money strengthens the company. But first the company needs to make its stock available. Let's understand this .

Imagine you had a magazine subscription selling job  in school/college and imagine teaching all the other kids how to sell subscriptions, collecting their money at the end of the day, using some of it to buy a prize for the top seller, sending a small amount to the magazines, and depositing the rest in your bank account. Pretty simple business model, right? Pretend for a minute that you did it and called it Mister Magazine.

First, you could have drawn up a business plan and pleaded with your principal/local bank.If you would have showed the bank manager your business model, my guess is that your interview would have been quite short. A lot of startup businesses face just that problem. They aren’t established enough to get a loan, or if they do get one it comes with such a high interest rate to offset the risk that it ends up strangling the business anyway. Nope, a loan wouldn’t do it for Mister Magazine.

1. Selling Stock Is a Great Way to Raise Money

Your second option would be to sell shares of Mister Magazine to investors who wanted a piece of the upcoming profits. By selling shares you would raise money, wouldn’t owe anybody anything, and would acquire a bunch of people who really wanted Mister Magazine to succeed. They would own part of it after all! You chose this second option to raise money, and  decided that 10 shares comprised Mister Magazine’s entire operation. You could have chosen 100 shares or 100,000 shares. The amount doesn’t matter. The only thing investors care about is what percentage of Mister Magazine they’ll own. You decided to keep 6 shares for you to retain majority ownership and sell 4 shares to your  friends  for Rs 100 each. They were your venture capitalists in this case. After the sale, you owned 60 percent of Mister Magazine and four friends in the community owned 40 percent. It was a private deal, though. You couldn’t find Mister Magazine listed in the paper yet.The first year of operation at Mister Magazine went great. You hired 20 kids to sell magazines door-to-door and  negotiated a cheap deal with the magazines, and found a wholesale prize distributor who sold gadgets for half their usual price. Your employees were happy and Mister Magazine grew to be worth Rs 5,000. How did your investors fare? Quite well. Those initial Rs 100 shares became Rs 500 shares in one year. That’s a 400 percent annual return!

Clearly there was only one thing for you to do. You needed to immediately drop out of school/college and expand Mister Magazine to outlying neighborhood, and then the entire India. It was time to come down out of the school office space and establish a ground-based headquarters. To fund this ambitious expansion,  you decided to take Mister Magazine public.

2. Going Public Raises Even More Money

Instead of selling shares to just four friends ,your next step was to sell Mister Magazine to millions of investors by getting listed on a stock exchange. Stock exchanges provide a place for investors to trade stock. Let’s see your chances of getting Mister Magazine listed on a major stock exchange.

(A)Bombay Stock Exchange (BSE)

Established in 1875, BSE is Asia’s first & the Fastest Stock Exchange in the world with the speed of 6 microseconds and one of India’s leading exchange groups. Over the past 141 years, BSE, as the first stock exchange in Asia and the pioneer of securities transaction business, It has also escalated the growth of the Indian corporate sector by providing it a capital-raising platform. 

(B)National Stock Exchange of India (NSE)

The National Stock Exchange (NSE), located in Mumbai, is the leading stock exchange in India. In 2015 it was declared as the fourth largest in the world according to the World Federation of Exchanges (WFE) in terms of equity trading volume. National Stock Exchange began its operations in 1994 and since 1995 it is ranked as the largest stock exchange in India in terms of total and average daily turnover for equity shares every year.

(C) India International Exchange (INDIA INX)

The India International Exchange (INX) is India’s first International Stock Exchange which is located at the International Financial Services Centre (IFSC), GIFT City in Gujarat. It is a wholly-owned subsidiary of the Bombay Stock Exchange (BSE). It was inaugurated on 9 January 2017 and trading operations were scheduled to begin from 16 January 2017. It operates 22 hours a day & six days a week.

3. Working with an Investment Banker

Obviously, Mister Magazine didn’t have a chance of making any of the three primary exchanges. But let’s say a colossal exception was made and you worked with the investment banking side of a large firm like Goldman Sachs, or JP Morgan to make an initial public offering, or IPO. That’s what a company’s first offering of stock to the public is called. You told the investment banker how much money you wanted to raise and the banker determined how many shares to sell at what price. Suppose you wanted to raise Rs 1 lakh. The banker could have sold 50 thousand shares at Rs 2 each, 1 lakh at Rs 1 each, or 20 thousand at Rs 5 each. As long as the combination produced the target amount, it didn’t matter.

The investment banker committed to buy the shares if nobody else did and got to keep a small amount of profit per share for this risk. The banker initially sold shares of Mister Magazine to the primary market, which consists of the banker’s preferred private accounts. After the primary market had right  on the tantalizing new shares of Mister Magazine, the investment banker offered the remaining shares to the secondary market, which consists of everyday man like you and me who read a stock’s price in the paper or online and buy it.

4. Making a Secondary Offering

Once the banker made the initial public offering, you had money and a bunch of new investors in the company. When it came time to raise more money, you sold additional shares of stock in what’s called a secondary offering. No matter how many additional times you sell more stock, it’s always called a secondary offering. You would also have the option of selling bonds to investors. When an investor buys a corporate bond, he or she is lending money to the corporation and will be paid back with interest. That means bonds have the same drawbacks that bank loans do. Mister Magazine would be forced to pay interest on the money it borrowed from investors instead of just selling them a share of stock in the company through a secondary offering.

Secondary offerings are sometimes necessary because companies don’t receive a dime in profit from shares once they’re being traded on the open market. After a company issues and sells a share of stock, all profits and losses generated by that stock belong to the investors trading it. Even if the price of the stock quadruples in value and it’s bought and sold ten times in a day, the issuing company doesn’t make any money off it. The reason is simple: the investor who buys a share of stock owns it. He or she can sell that share for whatever price the market will pay. The company isn’t entitled to any of the profits from the sale because the investor is the sole owner of that share of stock until it’s sold to a buyer who then becomes the new owner. Unless the company buys back its own stock, it won’t own the shares again.

It’s no different than you selling your car.  Do you owe Tata , a share of the sale price when you finally get rid of that old nano in your garage? Of course not. You place an ad in the paper, deposit the buyer’s check, and go on your way. It’s the same situation if you own shares of Tata Company. You place the sell order, take the buyer’s money, pay a brokerage commission, and go on your way. Tata doesn’t even know it happened.

    Now, you might be wondering why companies care what happens to their stock price once they’ve got their dough. After all, they don’t see any profit from you selling to me and me selling to another guy. That’s true, but remember that companies might want to make another secondary offering later, and another, and another, and another. If a company issues 1,000,000 new shares at Rs 40 it makes Rs 40 lakh. If it issues 1,000,000 new shares at Rs 10 it makes Rs 10 lakh. Do you suppose most companies would rather make Rs 40 lakh than Rs 10 lakh? Of course they would, and that’s why companies like to see their stock prices high. Not to mention that a falling stock price makes way for ugly headlines.

• How to Choose a Broker to Buy Stocks

You buy stocks through a brokerage firm. A brokerage firm is a business licensed by the government to trade securities for investors. Brokerage firms join different stock exchanges and abide by their rules as well as the rules laid down by the Securities and Exchange Board Of India (SEBI)

1. Two types of Brokerage firms

There are full-service brokerage firms and discount brokerage firms. Here’s a description of each:

(A) Full-Service Brokerage Firms

These are the largest, best-known brokerage firms in the world, who spend millions of rupees a year advertising their names. You’ve probably heard of Kotak ,Goldman Sachs, Morgan Stanley and others. They’re all the same. Regardless of their advertising slogans, the two words that should immediately come to mind when you hear the names of full-service brokerage firms are expensive and misleading. Other than that, they’re great. Most full-service brokerage firms are divided into an investment banking division, a research division, and a retail division.

       The investment banking division is what helps young companies make their initial public offering of stock and sell additional shares in secondary offerings. The brokerage firm keeps a profit on each share of stock sold. This is where the firm makes most of its money. Therefore, every one of the full-service brokerages wants to keep solid investment banking relationships with their public companies. Never forget that full-service brokerage firms make their money by selling shares of stock for the companies they take public. They make their money whether investors purchasing those shares get a good deal or a bad deal. In other words, it doesn’t make a bit of difference to the full-service broker whether investors make or lose money. The firm always makes money. To be fair, most brokers do want to find winning investments for their clients if for no other reason than future business.

  The research division of a full-service brokerage firm analyzes and writes evaluations, fact sheets, and periodic reports on publicly traded companies. Supposedly this information is provided to you, an individual investor, to help you make educated decisions. However, remember from the previous paragraph that the brokerage firm makes its money by maintaining solid relationships with companies. There are millions of investors, but only a few thousand companies. Whom do you think the broker wants to keep happy? The companies, of course. So, you’ll rarely see a recommendation to “sell” a stock. Instead a broker will recommend that you “hold” it. No company wants to see a firm telling investors to sell its stock. The brokerage’s solution is to just never issue that ugly word. The Wall Street Journal revealed how blatant this directive is when it discovered a memo from Morgan Stanley’s director of new stock issues stating that the company’s policy was “no negative comments about our clients.” The memo also instructed analysts to clear their stock ratings and opinions “which might be viewed negatively” with the company’s corporate finance department.

   The retail division is what everyone deals with. It’s comprised of brokers, who are really just sales reps, who call their clients and urge them to trade certain stocks. They charge large commissions that they split with the brokerage firm. The justification for the large commissions is that you’re paying for all the research the company does on your behalf. But as you now know, that research is misleading anyway. It exists simply to urge you to trade the companies that the firm represents. So, you are paying to receive a type of advertising! The only reason full-service brokerage firms have a retail division is so that they have a sales channel for the companies they represent.

When the investment banking division takes a new company like Mister Magazine public, the research division puts the stock on a buy list and the retail division brokers start making their phone calls. When you answer the phone and buy the stock, the broker and firm make money. 

(B) Discount Brokerage Firms

Discount brokerage firms do not conduct initial public offerings or secondary offerings. Most don’t have in-house research divisions, either. They just handle your buy and sell orders and charge a low commission to do so. The commissions are discounted because the firms don’t shoulder the expense of a full-service research department and a legion of sales reps in a retail sales department.

Most discount brokers offer research in the form of company reports, charting tools, newsletters, news summaries, and other helpful material. But they don’t have anybody call you to urge a buy or sell. The decisions are your decisions and the discount brokerage firm simply carries out your orders. Because they don’t maintain investment banking relationships with companies and because they make the same commission off any stock you trade, discount brokers don’t have an interest in selling you the stock of any specific company.

   By the way, there used to be a third category of broker called a deep discount broker that offered nothing more than cheap trading. Over the years, discount brokers lowered their prices and deep discount brokers added research and tools, so the distinction between the two categories disappeared. Now, lots of good research and fine online interfaces are available for low trading fees at companies from both former categories. So, I put them in the same category: discount brokers.Discount brokers are recent trend in india. Some of them are zerodha, angel broking, 5paisa, upstox, etc

• Technology Has Made Full-Service Brokers Obsolete

Full-service brokerage firms are anachronisms. They’re left over from the days when individual investors didn’t have access to the trading mechanisms that brokers use. To place a trade on an exchange floor in the old days, investors needed brokers and runners and agents to carry out that order. Investors were accustomed to paying a commission for all that trouble.

Think about that. If you know what stock you want to buy, shouldn’t you just type it into a computer or punch it into a touch-tone phone yourself? Of course you should! It doesn’t make

any sense to call a full-service broker—or in many cases, they’ll call you—and pay him or her a commission to type your stock trade into a computer. The full-service firms know this, of course, but they prefer to have you invest the way you would have in 1897 because they can get a lot of commission money out of you in the process.

   

• You Need to Double-Check Full-Service Information

Some would argue that the extensive research and hand-holding you get from a full-service brokerage firm make it worth the extra commission money. But the only thing you’ll hear from analysts in the research division of a full-service firm is what the marketing department encourages them to tell you. In other words, the stocks they want to sell in order to further their relationship with a public company will be pitched as good stocks for you to buy. Don’t assume that cold call from your brother-in-law the full-service broker has your interests foremost in mind. The advice might be good, but it might not.

Because you can’t just accept that a broker’s advice is good, you need to do your own research. So, why not just place the trade yourself, too? You’ll save a bundle.

• You Should Monitor Your Own Investments

Not only do you need to double-check everything full-service brokers tell you, the unsolicited phone calls you receive from them can be confusing. If you are a truly individual investor conducting your own research and placing trades with a discounter, you limit yourself to only what you need to know.

For example say you researched a stock and decided on a suitable purchase price and a target sell price. You told your discount broker what price to buy at. Two weeks later, the stock hit that price and you automatically picked up 100 shares. Then you told your discounter the price you wanted to sell at, say 30 percent more than your purchase price. That’s it. You went about your life and let the stock run its course. Six months later, it hit your sell price and you automatically sold all 100 shares and made 30 percent minus commissions.

     Notice that you—and you alone—decided what happened in the course of that stock ownership. Unbeknown to you, your stock dropped 30 percent in value before it made a roaring comeback to your sell price. If you’d gone through a full-service broker, there’s a good chance he or she would have called you when it was down and provided every negative headline regarding the company’s future. Maybe he or she would have caught you at a vulnerable time and you would have sold at a loss, all because you couldn’t choose your own information level. And, of course, the broker would make a commission on your sale at a loss and your subsequent purchase of a new stock.

       When you take care of your own investments, you choose what to monitor. Maybe you want to know every uptick and downtick of your stocks and every bit of news affecting them. But it might be that you just want the big picture by checking prices once a month, perusing top stories on the Internet, and keeping an eye on a few related stocks in the same industry. The point is that it should be up to you, not up to a broker who stands to profit off your frequent buying and selling. Keep the background noise low.

Key takeaways :-

✔ You need to invest in stocks because they allow you to own successful companies. When a company prospers, so do its owners. Stocks have been the best investments over time.

✔ You make money from stocks through capital appreciation and dividends. Capital appreciation is the profit you keep after you buy a stock and sell it at a higher price. Dividends are shares in the company’s earnings, which are paid to stock owners every quarter. Not all companies pay dividends.

✔ You should use a discount broker and make your own investment decisions. The advice you get from full-service brokers is worthless anyway, and they charge too much.