All you want to know about Shares

You must have heard stories of the fabulous returns made in the stock markets in recent months. And you longed wishfully for a piece of the action.

But you could also have heard horror stories of how a friend lost his shirt in the stock market.

And were promptly thankful that you didn't lose yours.

Let's set the record straight.

Wisely chosen (those are the key words), stocks are a must for any serious investor.

They add that extra zing to your collection of investments.

Study after study has revealed that over the long term, stocks outperform all other assets. That means you can expect to earn more from shares than from bonds, fixed deposits or gold.

No doubt the risk is higher with shares. But if you are in for the long haul, so are the potential returns.

But before you take the plunge and invest in the stock market, get your basics right.

This series will tell you about the basics of investing in stocks.

1. Stocks are not only for the brilliant

Stocks are far from being rocket science.

The strategies you need to know to maximise your wealth and the pitfalls you need to avoid are not beyond comprehension.

Even if you feel that you don't have the time, and prefer to entrust your money to a portfolio manager or mutual fund, the least you need to know is which funds are better, how to choose your fund manager, and keep a tab on his performance.

2. So what is a share?

Any business has a lot of assets: The machinery, buildings, furniture, stock-in-trade, cash, etc.

It will also have liabilities. This is what the company owes to other people. Bank loans, money owed to people from whom things have been bought on credit, are examples of liabilities.

Take away the liabilities from the total assets, and you are left with the capital.

Assets - Liabilities = Capital.

Capital is the amount that the owner has in the business. As the business grows and makes profits, it adds to its capital.

This capital is subdivided into shares (or stocks).

So if a company's capital is Rs 10 crore (Rs 100 million), that could be divided into 1 crore (10 million) shares of Rs 10 each.

Part of this capital, or some of the shares, is held by the people who started the business, called the promoters.

The other shares are held by investors. These investors could be people like you and me or mutual funds and other institutional investors.

3. What does this mean for me?

When you invest in stocks, you do not invest in the market. You invest in the equity shares in a company. That makes you a shareholder or part owner in the company.

Since you own part of the assets of the company, you are entitled to the profits those assets generate. Or bear the loss.

So, if you own 100 shares of Gujarat Ambuja Cement, for example, you own a very small part -- since Gujarat Ambuja has millions of shares -- of the company. You own a share of its assets, its liabilities, its profits, its losses, and so on.

Owning shares, therefore, means having a share of a business without the headache of managing it.

Your Gujarat Ambuja shares, for instance, will rise in value if the company makes good profits, or may do badly if people stop building houses and demand for cement falls.

4. What do mean by rise in value?

If the company has divided its capital into shares of Rs 10 each, then Rs 10 is called the face value of the share.

When the share is traded in the stock market, however, this value may go up or down depending on supply and demand for the stock.

If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and many want to sell the shares, the price will fall.

The value of a share in the market at any point of time is called the price of the share or the market value of a stock. So the share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).

If the number of shares in a company is multiplied by its market value, the result is market capitalisation.

For instance, a company having 10 million shares of a face value Rs 10 and a market value of Rs 30 as on November 1, 2004, will have a market capitalisation of Rs 300 million as on November 1, 2004.

5. So how does one buy shares?

Shares are bought and sold on the stock exchanges -- the two main ones in India are the National Stock Exchange (NSE), and the Bombay Stock Exchange (BSE).

You can use three different routes to buy shares: Through your broker, trade directly online, or buy shares when a company comes out with a fresh issue of shares. This is called an Initial Public Offering (IPO).

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Dividend

Usually, a company distributes a part of the profit it earns as dividend.

For example: A company may have earned a profit of Rs 1 crore in 2003-04. It keeps half that amount within the company. This will be utilised on buying new machinery or more raw materials or even to reduce its borrowing from the bank. It distributes the other half as dividend.

Assume that the capital of this company is divided into 10,000 shares. That would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 10,000 shares; each share would earn Rs 500. The dividend would then be Rs 500 per share. If you own 100 shares of the company, you will get a cheque of Rs 50,000 (100 shares x Rs 500) from the company.

Sometimes, the dividend is given as a percentage -- i e the company says it has declared a dividend of 50 percent. It's important to remember that this dividend is a percentage of the share's face value. This means, if the face value of your share is Rs 10, a 50 percent dividend will mean a dividend of Rs 5 per share (See What's in a share? Money!).

However, chances are you would not have paid Rs 10 (the face value) for the share.

Let's say you paid Rs 100 (the then market value). Yet, you will only get Rs 5 as your dividend for every share you own. That, in percentage terms, means you got just five percent as your dividend and not the 50 percent the company announced.

Or, let's say, you paid Rs 9 (the then market value). You will still get Rs 5 per share as dividend. That means, in percentage terms, you got just 55.55 percent as dividend yield and not the 50 percent the company announced.

Capital Gain

As the company expands and grows, acquires more assets and makes more profit, the value of its business increases. This, in turn, drives up the value of the stock. So, when you sell, you will receive a premium over (more than) what you paid.

This is known as capital gain and this is the main reason why people invest in stocks. They want to make money by selling the stock at a profit.

It is not as easy as it sounds. A stock's price is always on the move. It could either appreciate (increase in value) or depreciate (decrease in value) with respect to the price at which you purchased it.

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, then your return from that stock is Rs 10, or 100 percent.

Or, if you buy a stock for Rs 10 and sell it for Rs 9, you lose Rs 1, or your loss is 10 percent.

Now look at both: Dividend and Capital Gain

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, then your return from that stock is Rs 10, or 100 percent.

Add the Rs 5 per share you have received as dividend, and your total return will be Rs 10 plus Rs 5 = Rs 15 or 150 percent (Rs 15 divided by Rs 10 multiplied by 100).

If you buy a stock for Rs 10 and sell it for Rs 9 after a year, you would lose Rs 1 per share.

However, you would have got Rs 5 as dividend. So you would net Rs 4 as earnings from the company.

In percentage terms, your return would be 40 percent (Rs 4 divided by Rs 10 multiplied by 100).

Tax

One last point.

If you are a tax payer, the finance minister has made it very easy for you to invest in the stock market. There is no tax on dividend. Neither will you be taxed on long-term capital gains. This means, if you buy a share, hold it for at least a year and sell it at a profit, you don't have to pay any tax on the profit your make. If you sell it within a year, the short-term capital gains tax is only 10 percent.

Contrast this with fixed deposits, where you have to pay tax on the interest at your marginal tax rate. This means that, if you are in the 30 percent tax bracket and your interest income exceeds Rs 12,000 in a year, you'll have to pay tax on your interest income at that rate (including the surcharge, the cess, etc, the rate works out to almost 35 percent).

Investing in stocks may be more risky, but it is more tax-friendly. Besides, there is the potential to get a higher return on your investment.