In my previous post- Best Investment Avenues of 2018, I forgot to mention stocks which are an important and lucrative investment mode for all ages. The returns on a stock are higher than bank FDs adjusted for inflation. So what are stocks and how they are a gainful avenue of investment? Let’s find out.
If you are an equity holder, you are the owner of a proportionate share of the company’s assets and earnings. As an equity shareholder, you will enjoy voting rights and other privileges that only come with equity ownership. Equity shares are the primary source of finance for any company and give investors/ equity holders’ right to vote, share profits and claim on assets.
Equity capital is categorised into-
1. Authorized shares
2. Issued shares
3. Subscribed shares
4. Paid up shares
5. Rights shares
6. Bonus shares
The rate of return or profitability received by the owners of the equity is measured by the Return on Equity (ROE) ratio. ROE ratio denotes how proficient the company is in generating returns on the investment it has received from its shareholders.
Return on Equity = Net Income or Profits/Shareholder’s Equity & Shareholder’s Equity = Company’s assets – Company’s liabilities
Shareholder’s Equity is left over if the company decides to settle its liabilities at liquidation.
For E.g. Company ABC has generated a profit Rs.8, 00,000 and has issued 5000 shares to its shareholders of Rs.100 each. ABC earns profits and the board decides to issue dividend (earnings due to shareholders) worth Rs.1, 50, 000 to its shareholders, then Return on Equity (ROE) can be calculated as follows:
ROE = (8,00,000-1,50,000) / (5000 *100) = 1.3
In simpler words, for every rupee invested in ABC company, investors would generate Rs1.3 against their investment as their Return on Equity.
Now that we have a brief background of stocks, let’s find about their investment.
Investment in stocks is a lucrative investment provided you have selected the right stocks and have stayed vigilantly invested for a long time. Stock investments demand you to stay invested for a longer period generally 5 years and above for reaping out the gains. The last 10 years have seen equity funds in India generating about 12%-15% annualised returns, which is about 7%-8% above the rate of inflation.
Investment in stocks and enjoying the returns on your investment depends on finding the best stock mix for investment that might take a lot of time, fundamental analysis and research. If you are a first-time investor you need to precede the stock market with caution. The unpredictable movement of the stock market can even give the sleepless night to veteran investors. If you are a stock market investor or aspire to be one, here are the factors you should consider for a stress-free and rewarding investment.
Before you buy your first equity stock, study the stock market and get your fundaments correct. Know the concept of bulls and bears that drive the stock market, the concept of supply and demand which determines the stock price mechanism and the working of the Sensex including the time cut-offs.
A basic understanding of the Sensex and the economy will be helpful to analyse the profitability of an investment. Get your homework done by researching BSE/NSE official websites, and other market research driven web pages for a comprehensive information.
Make a list of the tentative companies you want to invest by buying their equity stocks. Check the company website and learn about its earnings and revenue projections through an analysis of its annual report. Additionally, you can read about the line of operations, services and basic business track record of the companies listed by you. A clever analysis can be reading about the dividend declared by the companies in last 10 years. This information will give you an idea of how stable the company’s fundamentals are and whether it can deliver equity profitability and dividend to its investors.
You should invest in the stock market with a long-term perspective, a minimum of 3 years. To stay invested for that long, invest in companies with strong fundamentals, relatively stable companies owned by the government and reputed business houses are stable investment options to begin. Follow companies dealing with products and services that have a constant demand. You can find the top performing companies in each sector like banking, oil and gas, telecommunication, manufacturing etc. and place your bets on them.
Invest in different companies, have a basket of different investments. For a start, you can buy top-performing stocks of 2-3 different sectors and expand your investment horizon as you gain experience in the stock market. If you choose to remain invested in one company or one sector chances are you may fall into losses if the company or the sector is not doing well. Multiple investments across several companies in different sectors will act as a cushion in adverse situations. When one company/sector is not doing well, your investments in other sectors will balance your losses out.
You should follow the news on business channels and newspapers to keep a track of the latest business news. News about policy changes, leadership changes, business projections are the ones to watch out for as they will have a direct effect on the price changes your equity stock faces in the future. Keep a tab on the industry news your company is a component of like if you have invested in oil and gas keep an eye on global crude prices and news, turmoil in the global process will have an adverse impact on your equity prices too. Stay informed.
Stockbrokers have their revenue targets to achieve, for that they may advise you to invest in companies that may look good in the present but may fade out in the future. Don’t fall into that, have your fundamentals correct and study the companies your broker advices you to invest in. Stocks with a short-term gain may look lucrative but these are the stocks that show the maximum fluctuations in the Sensex. One day they may go up and the next day they may come tumbling down, you don’t want your hard earned money to give you negative returns.
Stock markets do not guarantee you with high returns every time you invest. Some of your stocks may show profits while some may show losses, you have to be patient and not greedy with your investments. Many people may want to keep investing in a stock which is giving them low returns in hope for a turnaround, but that may or may never happen. Greed in the stock market may be your nemesis where you may lose your capital money invested as well.
My father says “stock markets should be a forgotten investment” where you forget your investments and return to them after 5-8-10 years depending upon your investment horizon and financial targets.
Share markets if invested wisely, with knowledge and a set time frame are a very lucrative investment, hoping the above tips help you choose the best investments suited to your financial needs.