Wednesday, May 27, 2015

INVEST IN EQUITIES, BASICS OF EQUITY INVESTMENT & BENEFITS TO A SHAREHOLDER


WHY SHOULD ONE INVEST IN EQUITIES ?

No matter where you are in life, equities have an important role to play within a properly diversified portfolio. They can help with building your savings, maximizing your income and protecting your wealth:

Building your savings
Historically, equities provide superior long-term returns compared to cash and fixed-income investments. However, equities typically fluctuate more in value. Because these fluctuations tend to smoothen out over time, it’s important to take a long-term perspective when investing in equities.

Maximizing your income
If you’re an income-oriented investor, your portfolio probably contains a high percentage of T-bills and government bonds. However, it’s important not to overlook the key role that equities can play in your portfolio. In addition, the income generated by equity investments— like dividends or capital gains—is taxed more favorably than interest income. Setting aside a certain percentage of your
portfolio to equities can enhance your after-tax income.

Protecting your wealth
Another reason to invest in equities is to protect your wealth. This may seem counterintuitive given that equities are not guaranteed,while fixed-income investments are. However, because fixed-income investments offer such low interest rates, they offer little protection from taxes and inflation eroding your wealth over time. Again, adding a certain percentage of equities to your portfolio, while keeping the balance in guaranteed investments, can help protect your portfolio’s value in the long run.

“Did You Know”
From April 1995 to April 2015, the S&P BSE Sensex has risen from 3,300 to 28,200, while CNX Nifty has risen from 1,000 to 8,600 during the same period

BASICS OF EQUITY INVESTMENT

As we have seen how equity investments can beat inflation, let’s understand the basics of equity investment & how can it be beneficial to shareholders. An equity share is a unit of ownership in a company. Every company issues a certain number of shares to its promoters, i.e., those who participate in its formation. The company issues additional shares to the public, when it raises money by way of an Initial Public Offer (IPO). Hence, in addition to the promoters, the public too becomes shareholders of the company. So, if you hold 100 shares of a company which has issued 10,000 shares, you own 1 per cent of the company.

BENEFITS TO A SHAREHOLDER

Why should you purchase shares of a company? What are the benefits that accrue to you as a shareholder? Apart from the right to vote and decide the future course of action that a company takes, the real benefit that you, as a shareholder, have is in the form of participation that you get in the profits made by the company. At the same time, your liability is limited only to the face value of the shares held by you.The benefits distributed by the company to its shareholders can be either Monetary benefits or Non-Monetary benefits.

  • Monetary Benefits : Monetary benefits can be in the form of Dividend or Capital Appreciation.

Dividend: You as an equity shareholder have a right on the profits generated by the company. Profits are distributed in part or in full in the form of dividends. Dividend is your earning on the investment made in shares, just like interest in case of bonds or debentures. A company can issue dividend in two forms:

  1. Interim Dividend
  2. Final Dividend: While final dividend is distributed only after the closing of the financial year; companies at times declare an interim dividend during a financial year. Hence if X Ltd. earns a profit of `40 crore and decides to distribute dividend of `2 to each shareholder & if you are a holder of 200 shares of X Ltd., then you would receive `400 as dividend. This is a return that you shall earn as a result of the investments made by you in X Ltd.

Capital Appreciation: You also benefit from capital appreciation. Simply put, this means an increase in the value of the company usually reflected in its share price. Companies generally do not distribute all their profits as dividend. As the companies grow, profits are reinvested in the business. This means an increase in net worth (capital of the company plus accumulated profits that have not been
distributed), which results in appreciation in the value of shares. Hence, if you purchase 200 shares of X Ltd. at `20 per share and hold the same for two years, after which the value of each share is Rs.35. This means that your investment has appreciated by `3,000/-.

  • Non-Monetary Benefits: Apart from dividends and capital appreciation, investments in shares also fetch some type of non-monetary benefits to you. Bonus and rights issues are two such noticeable benefits.

Bonus: Instead of distributing accumulated profits as dividends, companies have the option of issuing bonus shares, i.e., they will give more shares to you free of cost. Prima facie, it does not affect your wealth as a shareholder, however, in practice bonuses carry certain latent advantages such as tax benefits, better future growth potential, an increase in the floating stock of the company, etc. Hence if X Ltd. decides to issue bonus shares in a ratio of 1:1, and you are currently holding 200 shares, you will receive an equivalent number of shares (200) free of cost. Normally the price of the X Ltd. will then fall in the stock market to keep your overall wealth at the same level. This reduced price is known as the ex-bonus price.
For example, if the price of X Ltd. in the stock market was `40 before declaring this bonus issue, it would fall to `20 after the issue. Hence, your investment value which was `8000 (200 shares x `40 per share) would remain the same (400 shares x `20 per share). In case the bonus ratio was 1:2, i.e., for every 2 shares held the company issues 1 bonus share, you would have received 100 (200/2 = 100)
bonus shares.

Rights Issue: A company may need more money to expand and for that it may need to issue more equity shares. A rights issue involves issuing of additional shares to the existing shareholders of the company. A company wishing to issue additional shares should first offer them to its existing shareholders so that it allows the existing shareholders to maintain the same degree of control of the company.Thus you can maintain your participation in the company profits

“Did You Know”
From April 1995 to April 2015, the S&P BSE Sensex has risen from 3,300 to 28,200, while CNX Nifty has risen from 1,000 to 8,600 during the same period


UNDERSTANDING FINANCIAL LINGO



  • Equity : Equity is the ownership interest in a corporation in the form of common stock or preferred stock.
  • Stock Exchange : A stock exchange is a form of exchange which provides services for stock brokers and traders to buy or sell stocks, bonds and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and dividends.
  • Clearing Corporation : Clearing Corporation is an organization which works with the exchanges to handle confirmation, delivery and settlement of transactions. Such corporations play a key role in ensuring that executed trades are settled within a specified period of time and in an efficient manner. Clearing Corporation is also called as clearing firm or clearing house.
  • Index : Index is a statistical composite that measures changes in the economy or in financial markets, often expressed in percentage changes from a base year or from the previous month. Indexes measure the ups and downs of stock, bond and some commodities markets, in terms of market prices and weighting of companies in the index.
  • Bull market : Any market in which prices are in an upward trend.
  • Bear market : Any market in which prices are in a declining trend.
  • Benchmarking : Comparing the performance of a firm to a set of industry peers (the benchmark). Typically done across a variety of ratios and using both horizontal and vertical analysis. Industry peers are chosen based on size, industry code, location, etc.
  • Cash flow : In investments, it represents earnings before depreciation, amortization and non-cash charges. Sometimes called cash earnings. Cash flow from operations (called funds from operations) by real estate and other investment trusts is important because it indicates the ability to pay dividends.
  • Compounding : The process of accumulating the time value of money forward in time. For example, interest earned in one period earns additional interest during each subsequent time period.
  • Earnings per share (EPS) : EPS, as it is called, is a company’s profit divided by its number of outstanding shares. If a company earned `2 million in one year & had 2 million shares of stock outstanding, its EPS would be `1 per share. The company often uses a weighted average of shares outstanding over the reporting term.


QUESTIONS & ANSWERS


1.What is Capital Market?
The Capital Market is the market for long-term loans (debentures & bonds) and equity capital. Companies and the government can raise funds for long-term investments via the capital market. The capital market includes the stock market, bond market and primary market. Thus, organized capital markets are able to guarantee sound investment opportunities. The capital market can be contrasted with other financial markets such as the money market which deals in short term liquid assets and futures markets which deal in commodities contracts.

2. What is Financial Market?
The financial markets are markets which facilitate the raising of funds or the investment of assets, depending on viewpoint. They also facilitate handling of various risks. The financial markets can be divided into different subtypes:

  • Stock markets, which facilitates equity investment and buying and selling of shares of stock.
  • Bond markets, which provides financing through the issue of debt contracts and the buying and selling of bonds and debentures.
  • Money markets, which provides short term debt financing and investment.
  • Derivatives markets, which provides instruments for handling of financial risks.
  • Futures markets, which provide standardized contracts for trading assets at a forthcoming date.
  • Insurance markets, which facilitates handling of various risks.
  • Foreign exchange markets, these markets can be either primary markets or aftermarkets.

3. What is Stock Market?
A stock market is a market for the trading of publicly held company stock and associated financial instruments (including stock options, convertibles and stock index futures). Many years ago, worldwide, buyers and sellers were individual investors and businessmen. These days markets have generally become "institutionalized"; that is, buyers and sellers are largely institutions whether pension funds,insurance companies, mutual funds or banks. This rise of the institutional investor has brought growing professionalism to all aspects of the markets.

4. Who are the main participants in the Capital Market?
The capital market framework consists of the following participants:

  • Regulatory Institutions (e.g. SEBI) 
  • Stock markets
  • Market intermediaries, such as depositories, stock-brokers and Mutual Funds 
  • Investors

5. What are the different types of financial instruments?
The following are the different types of financial instruments:

  • Debentures
  • Bonds
  • Preference shares
  • Equity shares
  • Government securities

6. How do I buy financial instruments as investment options?
One cannot buy directly from the market or stock exchange. A buyer has to buy stocks or equity through a Stock Broker, who is a registered authority to deal in equities of various companies. In effect, a lot many intermediaries might come in between the buyer and seller, as brokers do their business through many sub-brokers and the like.

7. How risky is the Stock Market?
The general theory goes that the higher the profit, the greater the risk. Since there is scope for high profit in the Stock Market, investing in the Stock Market can be risky.

8. If Stock Market is so risky, why are people in it?
Basic human psychology. Men want profits- big and fast. Not many are deterred by the risks involved. The fact is that investment in the stock markets can give, potentially, the fastest ROI (Return On Investment), as the value of a stock can rise pretty fast, ensuring huge profit for investor. People buy shares in a company for either of two reasons:

  • They have a stake in the company. They are concerned not only in the future growth in stock value but in the worth of the company itself. Their investments are long-term and they don’t sell their shares in an impulse.
  • They want quick profit and don’t have any stake or interest in the company, but merely want some quick value addition. Their investments - both buying and selling - are impulsive. Mostly, they don’t do any market research and don’t follow any sector or company to gain proper knowledge before investing.

9. How can I achieve success in stock market?
The precept is very easy. Saving your investment is the first and most important part. This can be done by ensuring that you do not put your money in a company that does not show solid prospects. Fly- by- nights companies or companies whose shares touch the roof suddenly, need to be avoided. Companies that show a steady prospect are good to invest in. Needless to say, this process involves close acquaintance with market movements and a thorough understanding of the concepts involved.
The second thing is that adequate market knowledge is very important especially when you have invested in the stock market. One should be patient and judiciously responsive to market swings.

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