Stock for Beginners

Stock Investmentfor Beginners

Basics

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stock investment Basics

Stock Investment Basics

If you want your money to grow,

there are hardly any better

options than investing in stocks.

For equity investors, certain stocks,

properly selected and discarded, can

become the road to unimaginable

riches. When banks pay you 9% per

annum, every few years a handful

of stocks fetch anything between

100%-200%. If stock investing is

that rewarding, why are most people

averse to investing in stocks?

The reason is that making profits by stock investing isn’t easy.

This e-book makes it easier for you to understand what stock

investment is. It is for those investors who have never bought

stocks before and want to understand what the world of stocks

is all about and for those who depend on others’ advice and

predictions. Treat this is a stepping stone in your journey to make

the best out of stocks.








What are stocks and shares?Your share of Reliance, Infosys or

any other company represents

a share of your ownership in the

company. You own a slice of every

rupee of profit that the company

makes and have a claim on its assets,

proportional to your stake. As your

share of ownership, you get one

vote per share of stock to elect the

directors and to express opinion

on some decisions. The real point

of owning shares is to share in the

growth, innovation and wealth that the

enterprise economy creates.








What are the advantages of investing in stocks?There are two powerful reasons why you should invest in stocks

and they will work for you in the future, especially in a fast-growing

country like India.

Given that most savers are still young

and India is a growing economy, at

least 65% of your money should be in

stocks either directly or through mutual

funds and 25% in post office and 10%

in cash and gold. Select companies will

grow consistently over the long term with

the overall growth in economy. Create a

diversified basket of such stocks from

different sectors.

Short-term capital gains on stocks

attract only a 10% tax and long-

term gains attract zero tax. It is quite

perverse that speculative holding of

just a few days attract 10% tax and

passively earning money on money by

holding for a year attracts no tax while

business enterprises that create value

in the first place have to suffer a million

kind of taxes. This is an unthinkably huge

positive for stock investors. But that is

the wisdom of our tax-planners and so

go out and take full advantage of it by

buying stocks as long as low taxation

lasts on the risky speculative asset called

stocks.

Demographic aDvantage: tax aDvantage

65%

25%

10%

Stocks

Gold

Post office








Kinds of stocksCompanies can be classified by their market value, which is their

number of shares multiplied by market price. As defined by their

size, Moneylife divides stocks as mega, large, mid, small and micro

moneylife mega-cap stocks: Stocks of those companies whose market capitalization is higher than Rs10,000 crore

are classified as mega-cap stocks. These would include stocks of most well-known

companies like Hindustan Unilever, Reliance Industries, Infosys etc. All companies in

the two main market indices, Sensex of BSE and Nifty of NSE have mega-cap stocks.

These are also called blue-chip stocks.

moneylife large-cap stocks: Stocks of those companies whose market capitalization falls between Rs 10,000 to Rs

2000 crore are large-cap stocks, as per Moneylife classification.

moneylife miD-cap stocks: Stocks of companies whose market capitalization falls between Rs 2,000 to Rs 500

crore are classified as mid cap stocks








moneylife small-cap stocks:Stocks of companies whose market capitalization falls between Rs 500 to Rs 100 crore

are small cap stocks. The mid-cap and small-cap stocks are where the excitement as

well as the disappointment is. These companies grow fast and the best of them always

look pricey for their size and growth. Over time, however, some of them do justify their

high prices.

moneylife micro-cap stocks: Stocks of companies whose market capitalization is below Rs100 crore are classified as

micr-cap stocks by Moneylife.

Others such as business newspapers, exchanges and mutual funds may follow a

different classification.

value stocks: Stocks of companies that have excellent assets and potential for growth but may be

down in the dumps temporarily are called value stocks. Their prices would be lower

than what seems fair. There is a powerful investment approach that only invests in value

stocks because these are seen to be bargains.








operating profit: This measures the profitability of the core business operation and is expressed as sales

minus all costs except interest, depreciation and taxes.

profit after tax (pat):Also called net profit, PAT captures absolute profit, but should not be studied

independently, without looking at the sales-cost structure.

earning per share:EPS is expressed as net profit (profit after tax) divided by the number of shares. A

company with Rs 50 crore in earnings and a capital of 5 crore shares would have an

EPS of Rs 10. A continuously rising EPS is one of the most reliable predictors of future

price rise.

How to measure corporate performanceOne of the first tenets of long-term investing is to find a way to value

stocks based on the corporate performance. How do you measure

corporate performance? To invest in stocks or stay away from them,

you have to understand the following set of basic financial numbers

that signify a company’s health and its earnings growth:








cash flow: Reported PAT and EPS can be traps since PAT is an accounting number arrived at after

lots of adjustments. A company can show healthy PAT but may have a poor or negative

cash flow. A negative cash flow also indicates that there is a fundamental problem with

the company’s operations: either the profitability is too low or money is stuck in high

inventories and receivables.

profit margins:While profits are important, equally important is profitability – expressed as a

percentage on sales. Expressed this way, margins allow us to compare companies

across sectors and within a sector indicating how profitable the operations are.

return on capital employeD:RoCE is calculated by dividing profit before tax and interest cost by capital employed.

Capital employed is the total of all equity and preference capital, reserves and all debt.

RoCE measures how the entire money invested in business is doing. RoCE is best

compared to the cost of borrowing. If the interest on fixed deposits is 12% whereas

a company is earning about 14% as RoCE, clearly it is not a great business for

shareholders.

DiviDenDs: A key measure is regular dividends to shareholders that give them confidence that the

company is in sound financial health. When dividends are increased, the message is

that the company is prospering. When dividends are cut, investors receive the opposite

message and conclude that the company’s future prospects have dimmed.








How to select the right stocks

T he best stocks are those that have excellent financial performance and are not

valued highly. If the price is in an upward trend, it helps. This would combine value

with price action – an essential combination to win in the game of stock picking. The

three most important measures of performance are sales growth, growth in net profit or

Profit After Tax (PAT) and return on equity (RoE). PAT indicates the absolute profitability

of operations. EPS indicates the profit per share and RoE indicates overall profitability

on owners’ (shareholders’) funds invested. Once you have decided to identify good

stocks based on these parameters, you will have to estimate whether they are

overvalued or not. You must at all times avoid buying stocks with poor financials.








How to invest in stocks

The shares of a company are made

available to the investing public for

the first time through what is called an

Initial Public Offering. This is the first time

a company issues stock. This segment

of the market is called primary market.

You can buy these stocks from the stock

exchange once they get listed.

After an IPO is over, shares are

traded or bought and sold in stock

exchanges among investors in what is

called a secondary market.

primary market

seconDary markets








How shares are valuedPrice and value should determine

what to buy, when to buy and when

to sell. There are several approaches

to valuation. All of them are partially

true. You can use them only when you

know the context in which they are

useful as also their limitations. Shares

have an intrinsic value and a market

value and usually there is a huge

divergence between the two. Either the market value is too high or

too low. And therein lies the opportunity. The intrinsic value is the

underlying value of the business.

funDamental analysis:Theoretically, when you buy a share, you are buying a proportional share in a business.

So, to figure out how much the stock is worth, you should determine how much the

business is worth. To do this you have to make a detailed analysis of the financial

condition of the company. This is known as “fundamental” analysis. Some believe that

this is the only rational approach to valuing stocks.

Quantitative approach:There is another approach to investing. It is using computers and mathematics to

detect patterns, capture the pattern in models/formula and teach computers to provide








buys and sells based on these models. This is the quantitative approach to investing.

Applying quantitative tools is also called data mining. Quants or data miners develop

a hypothesis defining a relationship among various past data (prices, seasons/months,

streaks of winning or losing days etc.), then look for how statistically significant that

relationship is. This includes testing the relationship within data in different time periods,

market environments, etc., in order to test the robustness of theory. Finally, they would

take investment/trading positions by presuming that those past relationships would

continue to hold in future. It is as close finance can come to a scientific approach.

technical analysis:Technical analysis is the study of market action, using price charts, to forecast future

price direction. The central belief in technical analysis is that all factors that influence

market prices (fundamentals, political events, natural disasters, and psychological

factors) are quickly discounted by the market and prices reveal everything. Investors

who focus on chart readings call themselves technical analysts or chartists








Risks involved in stock investment

While blue-chip stocks do rise steadily over time, stocks are market-linked

products and so there returns are not guaranteed. Bonds return your money

at the end of the tenure plus interest. Stocks may go up and down and while all good

stocks pay dividends, it is not mandatory. Companies can go bankrupt and your

investment can disappear. How can you emerge as a successful investor? Consider the

following rules








Count-down to successful stock picking

10 ignore extremes: Technical analysis is the study of market action,

using price charts, to forecast future price direction. The central belief

in technical analysis is that all factors that influence market prices (fundamentals,

political events, natural disasters, and psychological factors) are quickly discounted

by the market and prices reveal everything. Investors who focus on chart readings call

themselves technical analysts or chartists.

09 avoiD Big losses: If a stock falls 90%, it has to rise by 900% to get

you back to where you were and that will not happen. So you can never allow

yourself a catastrophic loss. Put predetermined stop losses to avoid being wiped out.

Do whatever it takes to keep your downside limited and your upside unlimited.

08 keep it simple: It is not necessary to have complicated models for

success. For instance, the simple idea of buying blue-chips on large declines

works fine.

07 ego & emotions: Holding on to a stock thinking you are right or

because the company is good is a sure way to lose money.

06 patience: Unlike mutual funds you do not need to be always fully

invested. When the market is overheated by your valuation parameters and

there are hardly any picks with attractive risk-reward ratio, it is perfectly fine to wait.








05 risk control: Stocks are risky. Your returns depend as much on

controlling risk as much as fetching rewards.

04 Develop a methoD: If you don’t have a consistent method of buying

and selling, your returns will be pretty low.

03 learning from experience: Deep experience is an essential

ingredient. Unless you are born with exceptional personality traits, losses

will be a major part of life. It is even alright for traders to have a majority of losing

trades, provided the losses are small and the winners are big. Winners learn from their

experience of losses and take responsibility for it..

02 start small & stay informeD: It takes years to learn what

drives stock prices, the value of method and discipline and emotional control.

Until then start in a small way, especially if you feel very confident. Prudent investing

rests on keeping up with the flow of basic information. Smart investors seek intelligent

and consistent opinions and track some key investment parameters to ensure that

their investments are on track. They avidly read market history which helps clear our

minds about a lot of contemporary issues and trends. Besides, crunching numbers are

an important part of the stock picking process and successful investors do their own

number-crunching.

01 commitment: Winning stock pickers have a strong commitment to their

job of finding a winning edge, developing a method and sticking to it through

the rough and smooth.








16 Timeless Tips for profitable stock investmentHere is some timeless advice on stock investing

culled from experts:

01 An attempt at

making quick

money leads to losses

far higher than the initial

investment.

02 If stocks don’t

seem cheap by

historical standards, stand

aside or invest in very small

amounts.

03Buy and hold does

not work always

Never average down a losing

investment unless it is part of a

well-thought out method.

04 The best tip: there

is no such thing as

a hot tip.

05Don’t fall in love

with your stock; it

will never fall in love with you.

It will fall with the market.

06Valuations don’t

matter in the short

run and “short run” can last

for months and even beyond a

year.








07Calculate first how

much you can

lose, not how much you can

gain.

08Experts care about

risk, novices

dream about returns.

09Forecasts,

especially by

market experts are usually

useless.

10Develop a method,

stick to it and have

patience.

11Lots of humility

helps. A rising tide

raises all ships and so you may

have been just lucky.

12Stocks fall more

than you think

and rise higher than you can

possibly imagine.

13Investing in what

popular stocks, fad

industries and new ventures

are riskier than they seem.

14Bear markets start

in good times. Bull

markets start in bad times.

16Don’t assume

either the media

or fund managers know more

than you. Their record shows

they don’t.

15Neglected sectors

often turn out to

offer good values.








6 Stupidest Things People Say about stock investmentshow much lower can it go? After the bust of 2000, the four hottest stocks met with the following fate. Pentamedia

fell from Rs 2109 to Rs 4, DSQ Software fell from Rs 2820 to Rs 6. DSQ Software has

been now delisted from the exchanges and the promotor of the company is absconding.

Himachal Futuristic fell from Rs 2552 to Rs 7 and SSI with which the famous US stock

exchange Nasdaq even had a joint venture, fell from Rs 7200 to Rs 40.

how high can it possiBly go? As the saying goes, if you want to make 10 times your money, you can’t sell before the

stock goes up 10 times. But nearly all investors sell too early thinking how high can it

possibly go. The only way you make big money in stocks is letting them go higher - by

not taking a profit early. As another saying goes, let your profits ride...

it is only rs 20 a share, what can i lose?You can lose the entire Rs 20, a 100%. loss Whether a stock is Rs 5 or Rs 50 if it falls to

zero, it’s a 100% loss. Resist that “bargain.”

they always come BackOh yeah? SSI, DSQ Software, Pentafour... It is a silly and dangerous idea to assume

they come back. Besides, while you are waiting for them to come back, what about the

stocks that have doubled?








when it reBounDs, i will sellWe can hear it again and again. When it rebounds, you decide there was nothing wrong

with after all and decide to keep it. If it does not rebound... well, they all come back!

what me worry? i am long-term investorIn a bear market everything goes down. the best of stocks can lose up 60% of their

value as happened with Wipro between 2000 and 2003. Long term is often short term

goes sour and belief in the long term is simply a justification for people to not pay close

attention to your investments.








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