As the old adage goes, ‘There’s more than one way to skin a cat’ (special apologies to all the cat lovers out there), there’s more than one way to invest in the stock market. In our usual interactions with retail investors, we face tons of questions that usually center’s around what is stock market and what’s the best way to make money quickly.
In this piece, we have compiled all the FAQs (frequently asked questions) and present our understanding of the stock market with you.
What do you mean by stock market and shares?
If you break the two words, ‘stock and market’, you will quickly understand that it’s a marketplace (also called the stock exchange) where buyers and sellers of shares of a listed company execute their transactions. Just like there’s a market for vegetables, where sellers have a price for buyers to agree or disagree.
Shares are instruments of ownership in a company that gives its holder the right to vote and possible returns through price appreciation and dividends.
We see every day that prices of all companies change. What’s that?
Price is a function of demand and supply. For example, there are 1 lakh shares available of Siddharth’s company and Jinay wishes to buy them from the stock market. Then he puts an offer to buy shares at Rs. 10 which is the prevailing market price. But the current owner of shares, say Mr. X wishes to sell them for 11, then Jinay has 2 options either to rescind the buy offer or push the price to Rs. 11 per share. Hence, you see a change in price.
A retail investor is unable to see this becausethere are millions of buyers and sellers in the stock market. This influences the price of a particular stock or the entire market. Hence, a person willing to sell some stocks of a particular company puts a sell order on the stock exchange, showing his intent of selling the stock at a certain price. The stock exchange then finds a suitable buyer who is ready to buy at that price for such a sell order. If the price at which the buyer is willing to buy and the seller is willing to sell matches, a trade is executed and the price at which that share is traded becomes the prevailing market price (or the Share Price).
Oh! So you mean to say if the market is down today, I can buy anything and then sell it when the market goes up!
Yes, you can do that. You can buy or sell anything irrespective of the market movement. But it’s not as simple as it sounds. As a stock market participant, it’s fruitful to think like an owner of a particular company. Just because the stock is up today (which means price of your business is up), you will sell your business to any prospective buyer? Take a moment and think about it.
If you really want to earn in the market, you need to understand the value of that share in the business or company before buying it.
Contrary to the belief of a lot of elders, the stock market is not a gambling den or a lottery or a casino, if you exactly know what you’re doing.
What do you mean by value of shares?
Shares of a particular company derive their value from their underlying assets that represents the value of the company. Suppose you were to buy that business tomorrow with 100% ownership, then wouldn’t you want to know the value of its underlying assets that drive the company?
Generally speaking, the value of a company can be said to be an aggregate of the following:
- A strong asset base,
- An ethical & effective management making efficient capital allocation
- Stable past growth record & good future growth prospects
- Rising profits every year
(Note: there are many other factors linked to valuation, the above list is explanatory)
Is share value and share price the same thing?
No.
Value of a share is based on the fundamentals (including financial reports) and the future prospects of a company. Whereas share price is the price at which the investors in the market buys/sells that security. Share price keeps fluctuating based on latest trades of the market and can also deviate a lot from the share value.
How can it be different? Only a fool would buy expensive or sell cheap!
Finding the value of a company is as much an art as much it is a science (it’s a detailed topic on which soon we will publish a book). The value of shares also includes a portion of the future cash flows that a company expects to earn through its business. This is a subjective matter, as different people with different mindsets expect different outcomes from the same company. What’s expensive for you can be cheap/affordable for someone else. This is the premise on which every market in the world works.
Also, the stock market functions on absorption of news of various things such as socio-economic-political scenario, industry updates, company specific news, etc. which keeps changing their expectations & perceptions of growth in companies. What is perceived as affordable to buy today can be extremely expensive or cheap tomorrow.
Think about Reliance Industries. It’s the largest company by Market Capitalization of Rs. 15 lakh crores in India. Price of its share is around Rs. 2,300 which can be divided by total outstanding shares in the market. So for Rs. 2,300 to become Rs. 4,600, Reliance’s market capitalization has to become Rs. 30 lakh crores. Can it happen? Yes/No is your call. In the same fashion, Rs. 2,300 is cheap or expensive becomes a decision to make.
There is also one important thing that comes into play with it. The investor sentiment and behavior…
So you’re telling me stock price work on sentiments?
There is a school of thought which has been following this for decades. They say that the stock market is human nature and crowd psychology on daily display coupled with the law of demand and supply. We call this method “Technical Analysis”.
By definition, Technical Analysis evaluates price action in an index or a particular company and the identifies a trading opportunity. It does this by analyzing statistical trends gathered from trading activity, such as price movements and volume of shares traded.
They believe that human nature of greed and fear have stood the test of time over centuries and try to identify such times where they can trade and exploit those short term opportunities. There is no fixed time horizon for such investments as it can be done for a matter of hours and may even extend to months.
There are a lot of statistical tools and courses available in market to teach you this science. Yet it is not fool proof as the biggest secret sauce for this recipe is your JUDGMENT and CONVICTION to make that trade. In spite of identifying the opportunities correctly, if your judgment is not accurate or your conviction is not strong enough, you end up in the wrong direction.
Many stock market experts tend to look at the charts on business news channel and provide their views about any company or nifty or bank nifty. Right from 9:15 am in the morning to 3:30 pm, they try to continuously identify such trades. Some hit the target, some hit stop losses. No one actually knows because media often talks about winners let alone losers.
This method is also considered as “high risk, high return” as it is considered to be a source to make a quick buck.
If that’s how market operates, why bother with value of shares?
Absolutely. If it’s very easy to just understand what’s going to move up today, then it’s really futile to put in so much effort to figure out value in shares. But remember the golden rule of stock markets, it’s simple but not easy.
It’s simple because to make profit, your cost price should be lower than selling price. But it’s not easy to determine what will happen to the price of a share. Will it rise after you’ve bought it or continue to fall down? Nobody really knows that.
Therefore, we switch to another view called “Fundamental Analysis” or “Value Investing”. This discipline of investing involves study of company’s past and current annual reports, future prospects and projections, management team, industry, peers and so on. The objective is to derive a single number for that company which is known as the INTRINSIC VALUE (what the company is worth today based on their past and future data).
Value investors compare the prevailing market price with this intrinsic value to make a decision. If the market price is lower than their intrinsic value, the stock is said to be undervalued and they buy it and vice versa.
The time horizon is usually long, lasting up to eternity since this method is based on the fundamentals of the company and not dependent on human behavior.
It is considered as a slow and boring process. It’s definitely not as sexy and chest thumping as technical analysis. However, the people who have followed it religiously have multiplied their wealth umpteen times. The legendary investor Warren Buffett is the best example.
Okay I get your point. Guess what? If I do both, I can get the best of both worlds!
There’s an old Russian saying. “If you try to catch 2 rabbits at once, you will catch NONE”.
If you’re thinking that way you have FOMO!
Fear Of Missing Out is quite natural and common even among the people who have been trading and investing since years. You have to pick your side and stick your guns. It is okay to not be a part of a big rally as long as you know what you have already is a good bet.
The Golden Rule of the market is:
“THE MARKET NEVER GETS OLD!”
The BSE Sensex may have seemed expensive at 3,000 points in 1992, and yet, now it seems cheap at 20,000! It keeps throwing opportunities at you every second. It’s up to you which one to pick.
So which side do I pick?
Investment is as much as a behavioral game as much it is knowledge based. The more you doubt your methods, the more they will prove your doubts right.
Say you love Chocolate cake. A person comes to you and keeps a chocolate cake in front of you and says, “I’ll go out and get a bigger cake for you. Till then, make sure you don’t touch this one” and leaves you with your greatest temptation alone in a room. You look at the cake and see the chocolate layer melting and spreading around, watering every pore in your mouth. You get closer to take a whiff of that cake and it makes your stomach growl with hunger. There is absolutely no one to stop you and you have no idea how long will it be till that person will come back. What would you do?
- Forget the man and his other cake, this is in front of me, this is what I know that is real, YOLO. Let me take a bite. And another, and another…
- I know this is the best place I am in with this delicious melting cake and there’s no one to stop me. But let me wait. I’m sure, whatever will come will be far better and bigger than this. It’s worth the wait.
If you choose option a, your characteristic is more like a trader, but do understand the risk and rewards before you go deeper.
If you choose option b, you are more composed and patient to wait for what the future holds. You are inclined to value investing.
Okay but what we talked about above is just regarding your behavior. But what about the knowledge required for this?
If you really have the time to learn every aspect of trading or investing, you will find thousands of resources on the net that will help you cross the line.
If you feel this is too much coupled with your job / business, you can take help of a professional wealth manager who can guide you through various aspects of planning your finances through your life stages and also make investment decisions for you.
Keep in mind, the behavioral exercise will help you identify the perfect course or perfect manager who you can match your wavelength with!
For any queries, you can write to us at siddharth@indigenousinvestors.com or jinay@indigenousinvestors.com