Matrix of equity investments.
The lure of big money has always thrown investors into the lap of stock markets. However, making money in equities is not easy. It not only requires oodles of patience and discipline, but also a great deal of research and sound understanding of the market, among others.
In a country with a population of 1.3 billion people, just 2% invest in the stock markets. We want to dissect and demystify some common terminologies of the stock markets to bring you closer to the markets. The aim of this article is to get rid of the fear and uncertainty related to the stock markets. India is the next big thing in a macro-economic perspective and we want you to take part in this growth story. So, let’s dive straight in and look at some of the stock market metrics. Certain financial jargons or metrics which help us to ascertain the true worth of a given stock which will provide adequate information to take judgemental call whether to buy or not.
1. Stock price: Stock price is the amount of money you pay to buy a single unit of stock. If the stock price increases, after you have bought the stock already, it means you have made a gain or profit on the stock. If it declines, you are making losses. Since investors' fortunes are tied to the stock price, it is keenly tracked by them. While the stock price is widely followed, it communicates very little about the stock on its own. In order to put stock price in perspective, you will need to combine it with some other metric such as company earnings. For instance, when seen in conjunction with earnings, it tells you about valuations, that is, if it is value for money for you buy a particular stock at the current market price or not. More on this later.
2. Stock-price chart: A stock-price chart is the daily movement of stock prices plotted in a chart to observe a trend. It shows a progression of stock price over time. The 52-week range of stock price is frequently tracked. It tells you the highest and the lowest points the stock price has touched during a year. Prices of the stock at various time frames in the 52-week range can be correlated to various economic or socially important events to see how they affect the prices of the stock.
3. Market capitalisation: Shortened as 'market cap' or 'mcap', it tells you how big a company is. Market cap is obtained by multiplying the stock price by its outstanding number of shares. Roughly, a company with a market cap of up to Rs 5,000 crore is a small cap; one with an mcap up to Rs 25,000 crore is a mid-cap; and the companies over that are large caps. Market capitalization helps you relate the size of a company with another. It is a good comparison matric when looking analysing two companies.
4. Volume: Volume indicates how many trades are executed in a particular stock in a particular period. It shows the number of people are buying or selling a particular stock. Always invest in stocks with reasonably high volumes (in at least five digits) as it is easy to both buy (enter) and sell (exit) such stocks. Stay away from stocks that have anaemic volumes or exit will be difficult in stocks with ‘thin’ volumes
5. Earnings per share (EPS): EPS tells you how much money the company is making in profits per every outstanding share of stock. The higher the EPS is, the more money your shares of stock will be worth because investors are willing to pay more for higher profits. EPS is calculated by dividing the total profit of a company by its total number of shares. EPS splits the entire profit of a company across its shares.
6. Price-to-earnings (P/E) ratio: As stated earlier, it's not the stock price but valuation that tells you how expensive a stock is. The P/E ratio is one of the most important valuation tools. The P/E ratio helps determine the actual market value of the stock compared to the company’s earnings. It is calculated by dividing the stock price by 'TTM' earnings. TTM stands for trailing twelve months. TTM earnings are the earnings of the last twelve months or four quarters. P/E in turn is determined by host of factors- Earnings track record of the company, predictability and visibility of future earnings, promoter perception of the outlook of the company, sector view and general market condition. Generally, companies that are leaders in their sectors will always command a higher P/E than the other companies in the same sector.
7. Price-to-book (P/B) ratio: P/B ratio is used to compare the market value to the book value of a company. It is obtained by dividing the stock price by book value. Book value of a share is its worth in the company's books. Sometimes, the P/B ratio is also called the Price-Equity ratio. A P/B of under one indicates that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. So, beware of low P/B stocks. Having said that, the actual worth of share could be very different from what the company thinks it to be.
8. Price-to-earnings-growth (PEG) ratio: The PEG ratio goes deeper than the P/E ratio. It is calculated by dividing the current P/E of the stock by its earnings growth rate of a specific period. A PEG of less than one implies a cheap stock, that of more than one an expensive stock and a PEG of around one indicates a fairly priced stock.
9. Dividend yield: Dividends are the profits that companies share with their shareholders. Dividend yield is obtained by dividing the dividend per share by the stock price. The higher the dividend yield, the more money you get as dividends. A relatively low dividend yield could mean that the company is retaining more earnings toward developing the firm instead of paying stockholders, which hints at future growth.
The Flip side of dividend yield is that a company paying higher dividends is doing so because it cannot profitably reinvest its earnings in its business to generate incremental earnings which will trigger a lower P/E.
Generally, 1-2 % will be the dividend yield for a growth stock. Companies in the Utilities sector and some others in sectors which are slow movers will give a much higher yield. When it comes to dividend yield, one has to choose between the hen and the egg.
Although no sure-shot formula has yet been discovered for success in stock markets, here are some golden rules which one should follow prudently which may increase the chances of getting a good return.
Avoid the herd Mentality:- The typical buyer’s decision is usually heavily influenced by the actions of his acquaintances, neighbours or relatives. Thus, if everybody around is investing in a particular stock, the tendency for potential investors is to do the same. But this strategy is bound to backfire in the long run.
Take informed decision:- Proper research should always be undertaken before investing in stocks. But that is rarely done. Investors generally go by the name of the company or the industry they belong to. This is not the right way of investing.
Invest in business you understand:- Never invest in a stock. Invest in a business instead. Invest in a business you understand. In other words, before investing in a company, you should know what business the company is in.
Don’t try to time the market:- one thing that even warren buffet doesn’t do is to try to time the market. A majority of investors, however, do just the opposite, something that financial advisors have always been warning them to avoid, and thus lose their hard earned money in the process
Follow a disciplined investment approach:- Historically it has been witnessed that even great bull runs have shown bouts of panic moments. The volatility witnessed in the markets has inevitably made investors lose money despite the great bull runs. However, the investors who put in money systematically, in the right shares and held on to their investments patiently have seen generating outstanding returns. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long term broad picture in mind.
Do not let emotions cloud your judgement:- Many investors have been losing money in stock markets due their inability to control emotions, particularly fear and greed. Instead of creating wealth, these investors thus burn their fingers badly the moment the sentiment in the markets reverses.
Create a broad portfolio:- Diversification of portfolio across asset classes and instruments is the key factor to earn optimum returns of investments with minimum risk. Level of diversification depends on each investors risk taking capacity.
Have realistic expectations:- There’s nothing wrong with hoping for the best from your investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions.
Invest only your surplus funds:- If you want to take risk in a volatile markets, then see whether you have surplus funds to invest, never invest with borrowed money.
Monitor rigorously:- We are living in a global village. Any important event happening in any part of the world has an impact on our financial markets. Hence we need to constantly monitor our portfolio and keep affecting the desired changes in it.
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