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16 October, 2021 20:22 IST
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What are stocks

Quite simply, if you own a stock, you own a piece of the company. You own a share of every bit of what the company owns even the CEOís limousine, if you please. What more, even while you are a part owner you neednít walk into the company headquarters even once.

Great? While all this sounds nice, itís just a notional picture of stocks. Rarely do stock investors get so much control. Even manage a free ride in the limousine! So whatís the truth?

If those little valuable pieces of paper called share certificates carry your name on them, you can say you have equity in the company whose name appears on the top of the certificate. Equity is the part ownership of a company in the form of its stocks. The number mentioned on each share certificate tells you how many stocks of the company you own.

Then what are a companyís stocks?

Worldover, people who start a company usually do not have enough money to kick-off. So they look elsewhere and try to rope in others to chip in. They divide the entire capital that the company needs into a large number of units of easily affordable amounts. For example, if a company requires a capital of Rs 1 crore, it may divide it into 10 lakh units of Rs 10 each. Such units are called stocks and Rs 10 is known as the par value of the stock. Thus, anyone with a few hundred rupees to spare can invest in the company.

There are two obvious benefits of raising money this way. Firstly, it lets an entrepreneur to think of starting a business even if she does not have all the money required. Secondly, it allows small investors to participate in wealth creation and benefit from an important economic activity.
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What is the stockmarket?

Aha! Thatís one place you could have never missed in the financially turbulent nineties. It has been the shrine of money making.

We all know it, the bhaji market in your neighbourhood is a pl`ace where vegetables are bought and sold. So, no big deal in defining a stockmarket as a place where stocks are bought and sold. You deserve to know more.

The stockmarket determines the day's price for a stock through a process of bid and offer. You bid to buy a stock and offer to sell the stock at a price. Buyers compete with each other for the best bid, i.e. the highest price quoted to purchase a particular stock. Similarly, sellers compete with each other for the lowest price quoted to sell the stock. When a match is made between the best bid and the best offer a trade is executed. In automated exchanges high-speed computers do this entire job.

Stocks of various companies are listed on stock exchanges. In India, the Bombay Stock Exchange (BSE), the National Stock Exchange (NSE) and the Calcutta Stock Exchange (CSE) are the three large stock exchanges. There are many small regional exchanges located in state capitals and other major cities.

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How can I make money from stocks?

There are two ways in which you make money with stocks.

The first, the now-and-thenly source, is through capital appreciation. A week later if the stock price of the scrip you hold has doubled to Rs 20, by selling it you have earned a return of Rs 10 as capital appreciation. You have made money by a 100% appreciation in the stockís price. Through this way your fortunes will perpetually keep fluctuating. Thatís because it depends on the stockís price, which is always on the move even if fluctuations are incremental. Chances are your invested capital is either appreciating or depreciating.

The other way to make money through stocks is dividend. The company whose stock you own may have made huge profits which it will have to share with all stockholders. Such shared profits are called dividends. Being ordinary shareholders, as we told you, you may or may not get dividends, hence, this bit of earning through stocks is not assured.

Dividends can be a good earning, more so because they are non-taxable in your hands since now only companies have to pay tax on the dividend they disburse. Shareholders sometimes prefer to do away with dividends. This is specially so for small and fast-growing companies. Investors in such companies feel it is better to plough back the earnings for growing the business rather than distribute as dividends.

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Acquiring stocks

You can acquire stocks of a company in two ways. You can buy shares when a company makes a primary issue, that is, an offer to the general public to subscribe to its equity. In a primary issue, the company has the right to set the price for its shares. It may set the price at par value or it may charge a premium for it. Once an issue is subscribed to and the offer period ends, the stocks are listed on the stockmarket. Now, it is left for the market to determine its value.

There is a secondary way of acquiring stocks. You can buy and sell stocks at the market-determined price. All stock exchanges are thus secondary markets. For getting stocks from the secondary market you need the services of a brokerage firm who acts as your agent whenever you want to buy or sell a stock.

When you buy stocks you get a share certificate which also mentions the number of stocks you hold. You have the option of keeping the share certificates with you or letting your broker hold the share certificates for you.

These days, for about 80% of the stocks listed on the BSE and the NSE, you can own them electronically. Instead of physical or `materialí share certificates, in the electronic system you own dematerialised (or demat) shares. This is also referred to as demat account because it is actually a statement of all the stocks you hold in the electronic form.

With demat shares you donít have to worry about maintaining stacks of share certificate papers. Gone are the days when one has to sit and sign a number of transfer deeds, send to the registrars for transfer and being worried of it being lost in transit. When you want to purchase a demat share your broker asks for your depository (a company which is a custodian of your shares in the electronic form) name and your account number on the date of settlement of the exchange. The broker transfers the shares electronically into the depository and the ownership of the share automatically gets accounted for in the companyís book of accounts.

These days many investors buy and sell stocks on the internet. And the orders that you place is handled entirely with computers. All you have to do is log on to the brokerage firm's site, open an investor's account, enter your order, wait for the trading to be done and within some time get a confirmation to your order.

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Is equity risky?

All over the world, equity has traditionally yielded the maximum return on investment. Which is what any investor wants - the most bang for his buck. So invest in equity and live happily ever after. Well, if only life was so easy!

The returns on equity investment are high, but so are the risks. This apparent contradiction is easily understood. As an investor in the equity of a company, you become an owner of that company to the extent of your investment. As an owner, or a part owner, you face the same risks and potential returns as the company does. So, if your company is earning profits, so will you. But if starts bleeding losses, you will lose too. So what should you do? Remember the advice that Aby Joseph, the analyst from Goldman Sachs, recently gave to Indian investors (she said it for the US-BASED NASDAQ exchange): "Be careful." She was, of course, talking about investing in IT stocks. But his advice applies to all investments.

Worst comes to worst your liability as an equity investor is restricted to only the face value of the share.

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