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Stocks Basics
What Are Stocks?
What Is Stock Market?
How Can I Make Money From Stocks?
Acquiring Stocks
Is Equity Risky?
Types of Stocks
Two Classes of Stock
Buying and Selling
Why Do Stock Prices Go Up And Down?
What On Earth Are Circuit Breakers?
Buying and Selling Stocks
Settlement of a Trade
Margin Trading: The Long and Short Of It
Badla? What’s that?
Zooming In: Research Individual Stocks
Benchmarking a Stock
Stock Picking
Choosing a Stock

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 CEO’s limousine, if you please. What more, even while you are a part owner you need not walk into the company headquarters even once.

Great? While all this sounds nice, it’s just a notional picture of stocks. Rarely do stock investors get so much control. Even manage a free ride in the limousine! So what’s 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 company’s stocks?
World over, 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.

What Is Stock Market?

Aha! That’s 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 place where vegetables are bought and sold. So, no big deal in defining a stock market as a place where stocks are bought and sold. You deserve to know more.

The stock market 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.

How Can I Make Money From Stocks?

There are two ways in which you make money with stocks. The first, the now-and-then-ly 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 stock’s price. Through this way your fortunes will perpetually keep fluctuating. That’s because it depends on the stock’s 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.

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 stock market. 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 'material' 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 don’t 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 company’s 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.

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.

Two Classes of Stock

We live in a class-ridden society. Stocks too have their two major classes or types: ordinary and preference. Ordinary stocks, sometimes also called equity stocks or common stocks, are really for the general public without any bar. You, me and just anyone can buy them (and proudly say we have a stake in the company).

Before we step further, let's clear one thing upfront. By equity we mean stocks, right? And vice versa? We use equity and stocks interchangeably. Equity refers to ordinary stocks. And that’s what concerns us here because only ordinary stocks can be purchased by people like you and traded on the stock exchanges. Stocks again refers to equity. Unless we mention preferred stock, stock is always the other type meant for us. OK?

Individual investors can also acquire preference stocks, just that companies in India haven’t bothered to offer them so far to the general public.

Holding equity (savvy way of saying you own those pricey little share certificates) entitles you to a share of the earnings and the assets of a company. What that means is that if a company records profits for a year you are entitled to a share of the profits. The share of the profits or earnings the company is decides to give you is called dividend.

How nice! But did you get the catch when we said on `entitled` and `decides to give you`? Because what happens is that ordinary shareholders will only get the dividend after everyone else, i.e. preference shareholders have settled their share of the earnings. So, if the company chairman says no dividends this year, you can't kidnap him till he comes out with your dividend unless of course, you have no other way to earn infamy.

Preference shareholders are privileged guys. They get their share of the earnings before the ordinary shareholders. In other words, preference stocks will always have an assured dividend. Whether those shareholders actually get paid depends on whether the company has enough resources to pay up. If that was not enough, those privileged guys also have the "added" advantage. All their missed dividends keep getting added while for ordinary shareholders dividends once missed are missed forever! And when the company does declare windfall profits, it will first pay the cumulative dividends of the preference shareholders and then the ordinary shareholders.

Cheer up, the flip side is, those privileged guys don't get to trade their stocks on the exchanges. That’s because though legally preference shares can be listed on exchanges, nobody has ever done so. This means that preference stocks don't appreciate as much as ordinary stocks do.

Let's say quits! Enough of investing and now you want your money back. To redeem is to get back the principal (i.e. the price at which you purchased) in any security like a bond, a preference stock, or a mutual fund share before or at the time of maturity. For a company or an institution that issued you the security, redemption then means, quite simply, buying back the security.

Ordinary stocks are not redeemable. Once out of the company's kitty, the company doesn't have to pay back its equity stocks until it shuts down. Hence, for a company, equity shares provide it permanent capital. One fine day if you decide to get rid of the stocks of a company, you can’t walk into the company and ask them to buy back or redeem the shares from you.

What you can do, and as the law permits, is to transfer those ordinary shares to someone else. A job that your broker will do for you. Unless you are too benevolent, transfer doesn’t mean you hand over your share certificates to your broker. You actually sell it for a price, and sometime make a killing out of it. As to how one can make money out of stocks, a little later.

Preference shares are redeemable. The company can repay the shareholder in return for the stocks. The amount repaid in most cases includes the premium over the current market price of the stock. Usually preference stocks are issued to shareholders for a particular period. A company can also, if it feels it's too costly to keep paying dividends, buy back preference stocks after serving a proper notice to the stockholders.

If you have realized preference stocks are not exactly pure stocks. They are a cross between equity stocks and bonds, which have an assured dividend. There are some preference stocks, however, which are non-cumulative; the dividend lapses if the company is unable to pay it. Preference stocks are generally tradable. There are some convertible types that allow the shareholders to convert such stocks into ordinary shares after a particular period or after fulfilling certain conditions. There are also a non-redeemable variety of preference stocks where such stocks can only be redeemed at the time of a company's liquidation. Preference stocks are generally given out to banks, financial institutions and rich guys with high net worth.

Holding equity also gives you the right to vote for the company's board of directors. The number of votes depends on the number of stocks you hold. On a special gathering every year called the annual general meeting (AGM) you also get to vote for or against the company's annual report placed before all shareholders. However, preference shareholders don't get to vote in the AGM.

All that is solid melts into air. Apparently healthy companies sometimes wind up all of a sudden. As a part owner, all shareholders get paid according to their stake in the company. Ordinary shareholders will be the last to get paid. All debts of the company must be settled first, including the claim on the assets of a company by the preference shareholders. It could well be that ordinary shareholders get nothing if no assets are left after clearing off debts and paying preference shareholders.

As an equity shareholder you also have what are called pre-emptive rights. That means that in case a company decides to offer new equity shares existing equity shareholders are offered first before the company can go to the open market with a public offering.

Why do stock prices go up and down?

Fluctuations in a stock’s price occur partly because companies make or lose money. But that is not the only reason. There are many other factors not directly related to the company or its sector. Interest rates, for instance. When interest rates on deposits or bonds are high, stock prices generally go down. In such a situation, investors can make a decent amount of money by keeping their money in banks or in bonds. Why should they face the extra risks of the stock market?

Money supply may also affect stock prices. If there is more money floating around, some of it may flow into stocks, pushing up their prices. Other factors that cause price fluctuations are the time of year, and publicity. Some stocks are seasonal; they do well only during certain parts of the year and worse during other parts. Publicity affects stock prices. If a newspaper story reports that Zee Television has bought a stake in Asianet, odds are that the price of Zee’s stock will rise if the market thinks it’s a good decision. Otherwise it will fall. The price of Asianet stocks may also go up because investors may feel that it is now in better hands. Conversely, if an article says that a company's president is a crook and has used the money raised to build a palatial bungalow for himself, then it is a good bet that the price of that company’s stock will fall.

Thus, many factors affect the price of a stock. The behaviour of the price movement of a stock is said to predict its future movement. The behaviour is analysed by plotting on a graph the price movement against any standard index. This is called technical analysis. It tells you when to buy a stock. Analysis of the fundamentals of a company, on the other hand, tells you which stock to buy.

Ek-ka-do. Stocks also go for splits. One fine day if the company whose 50 stocks you own and having a current market price of Rs 40, declares a 2-for-1 split, you will now own 100 stocks of the company. The market will then halve the price, unless it has reasons to be more bullish, to around Rs 20. Stock splits should not normally raise the value of your stocks, since the prices fall to compensate for the larger number of shares held. The main advantage of a stock split is that it improves liquidity. You can sell 50 shares and retain the other 50.

Usually companies go for stock splits when the stock's price zooms up to some phenomenal level and hence, becomes out of reach of many investors. Splits in such cases make stocks affordable and usually lead to increased buying and, hence, also increase liquidity. Naturally, it is expected that the stock's value will make an upward ascent soon after the split and investors will stand to gain.

We can also have a do-ka-ek. Companies sometimes declare to retire their stocks in a certain proportion of their outstanding stocks. Hence, a 1-for-2 reverse split would mean that any shareholder will now own half the number of shares with the price of each being double as before the reverse split. However, the total value of the holding will remain the same on the day of the split. Reverse splits are currently not allowed in India though companies can buy back their shares up to a certain percentage of the outstanding number of shares.

Companies usually go for reverse splits to boost up the stock's price, which might be performing badly for a long time. A hiked price might invite more investors.

What on earth are circuit breakers?

A circuit breaker is a tool to control trading of shares by setting a limit on price movement. It is like a red signal for speeding shares. Regulatory bodies are generally wary when stock prices rise or fall too fast. In order to give time to the markets to recover their poise, stocks that rise (or fall) above a certain percentage are stopped from trading. As of now the two main exchanges, The BSE and the NSE have two upper and two lower limits. If a stock prices hits the first upper limit of 8%, i.e. the stock’s prices rises by 8% from the price at which it started trading for the day, the exchange halts trading of the stock for half an hour, which is called the cooling period. And if even after the cooling period the stock maintains its upward climb and hits the second upper limit of 16%, trading of the stock is stopped for the day and resumed the next day. Similarly, for falling stocks there are lower limits set at 8% and 16%. The circuit is thus the band between the lower and upper limits. Circuits are built to check the volatility in the market, to arrest panic and to keep the market under some control.

Buying and selling stocks

Till 1995, the Bombay Stock Exchange, India’s oldest stock exchange and also Asia’s oldest, worked on the open out-cry system of stock trading. The out-cry system followed a system of public auctions in which verbal bids and offers are made for stocks on the trading floor. Remember those frantic scenes -- men running around, shouting at the top of their voices and exchanging signs. Things have got a bit more civilised since then! In 1995 the operations and dealings of the BSE were fully computerised and the out-cry system was replaced by the fully automated computerised mode of trading known as BOLT (BSE On Line Trading) System.

Settlement of a trade

A buyer of a stock has to pay the seller and get the stock in return, exactly like buying vegetables in the local market. Well, the problem is unlike a vegetable market, buyers and sellers are not physically present in the stock market. India does not yet have the infrastructure to facilitate the transfer of stocks and money between buyers and sellers on a daily basis. Therefore, we have a settlement period. If the settlement period is seven days, the actual transfer of stocks and money will take place at the end of the period, i.e. every seven days. The BSE and NSE both follow a settlement period of one week.

The trade date is the date the deal was struck or the trade of stocks was executed. Settlement date is the date on which a trader is supposed to give delivery of shares or give money for the shares he has purchased. On the BSE the settlement date is Friday and on the NSE the settlement date is on Tuesday.

Margin Trading: The long and short of it

Let’s say you strongly feel that the price of a stock will go up and so much so that you don't mind taking some risk or added expense. You can make money by buying the stock now and selling it later when the price has increased. But what if you don’t have the money to buy? Well, you could "go long" on that stock, i.e. you ask your broker to buy the stock without paying him the full amount now. Instead, you can pay him a token amount called the margin money. When you buy on margin you are actually buying stocks on credit.

Your broker will lend you the part money if you have enough collateral in the form of adequate stocks in deposit with the broker. Since it’s a loan the broker is giving you he will also charge an interest. You could have also borrowed money from some other sources to buy those stocks. But usually brokers try to offer interest rates lower than other sources.

When the stock's price has indeed gone up, you sell the stock, pay the broker the price at which you had purchased it and pocket the difference (less the interest cost of the broker's loan and the transaction cost).

Buying long allows you to buy more shares than you can afford. And, if your hunch about a stock's price rise turns out to be correct, you stand to gain more than what you could have without a margin buy. But the longer it takes for the stock to rise to the price level you had expected less will be your gain. To be safe the stock price should rise enough to pay off the loan amount, the interest incurred and the transaction cost.

Buying long becomes risky if your calculations go wrong. If it takes a much longer time for the stock price to reach the level than what you had estimated, your profits will reduce because by that time the interest cost on the borrowed money would have also risen. And if your estimate completely goes wrong and the stock's price falls you immediately start making losses. To be safe the stock price should rise enough to pay off the loan amount, the interest incurred and the transaction cost.

The other type of margin trading is short-selling. "Going short" is the opposite of buying long and investors do it when they expect the price of a stock to fall in the short run and profit from this drop. Lets say, you tell your broker you want to short-sell 100 shares of Tata Tea which are currently priced at Rs 40 each. This quarter's results of the company aren't encouraging enough and you are convinced the stock price will take a beating within a few days. The broker looks for someone who has 100 shares of Tata Tea and borrows them on your behalf for a short period and with the guarantee that you will return them in few days. You in turn sell these borrowed shares at Rs 40 each and hence get Rs 4,000. Now, if what you had hoped for does happen, and the price of the stock falls to say, Rs 20 after two days, you will do what is called "cover the short position". That means you buy back the 100 shares by spending Rs 2,000 and your broker in turn returns them to the person borrowed from. So, by short-selling you have earned Rs 2,000 (of course, slightly less after adjusting for the transaction costs and expenses for borrowing the stock). The advantage of selling short is that you get to sell borrowed stocks without putting in your money.

Short selling can be perilous. Suppose if the Tata Tea shares fall but only do so marginally, you might just be able to recover your money. Or if the shares take a much longer time to reach the Rs 20 level than you had hoped for, your interest on the money with which the broker had borrowed those shares will surmount. Additionally, there will be constant pressure from the lender to return the stocks. Worse still, if instead of falling, the stock price rises, you will immediately enter into a loss.

Both short-selling and buying long require a good reading of the market and correct timing.

In both cases of margin trading you are actually trading shares on credit that you have taken from the broker. If you have bought or sold a stock on margin and the stock's price reaches a level that makes it difficult for your broker to recover the credit, your broker will give you what is called a margin call. The broker might ask you for more collateral in the form of stocks or ask you for additional funds. If it becomes worse the broker will sell the stocks, in case you had gone long, and ask you to repay the loan.

Badla? What’s that?

Badla means something in return, for instance, interest. It is a common expression in Indian stock markets for the Carry Forward system under which one postpones the delivery of or payment for the purchase of securities from one settlement cycle to another. The BSE allows the badla mechanism only on a hundred stocks and a badla session happens every Saturday. The NSE allows a form of badla known as the ALBM segment (Automated lending and borrowing mechanism) which takes place every Wednesday.

Under this system, a buyer and seller have the option to carry forward their trades to the next settlement without effecting delivery of shares sold or making payment for shares bought. Simply put, badla is the price payable by the buyer to carry over his speculative purchases to the next settlement. The system helps build large volumes on the exchanges and imparts liquidity to stocks. The positions at the end of a settlement period are carried forward to the next period.

Zooming in: Research Individual Stocks

Time to get your scalpels out and scrutinise your stocks minutely. Yes, almost like a professional analyst would do.

Just a recap: A stock is a unit of ownership of a company that the public can own and trade. A stock’s value is dependent on many things. Among many things, the value could depend on how the company’s business is faring. It could also depend on how the stock is traded on the stock exchange. Analysing stocks, or assessing their value, hence takes two widely followed methods of analysis, the fundamental and the technical.

A fundamental analysis looks at all things that could possibly affect the business of a company.

Some of these things looked at are: the company’s sales and earnings, the operating margins, the balance sheet, the composition of the top brass, the company’s clientele, the prospects of the industry it is in, competition it faces and so on.

You need to know how much has the company sold and how much are its profits. Investors always go for a company with high sales and good profits. Companies with sales and profit figures more than the industry average are generally preferred.

Operating margin and net operating margins tell us about the profitability of a company. In mathematical terms they are ratios expressed in percentages of the company's gross profit and net profit to the sales, respectively. A debt-to-equity ratio is a measure of a company's leverage, calculated by dividing long-term debt by common shareholders' equity. The ratio for a company depends on the industry it functions in. A high ratio indicates a good chance that the company won't be able to service its debt in the future. However, the company's debt/equity ratio should generally be below the industry average.

Just impressive sales and profit figures don't impress many investors. They also judge a company by its growth rate i.e., rate of growth in sales as well as profits. A fast growing company has good capital appreciation. Good growth is also a reflection of quality management. One also checks for growth rate figures to be consistently above the industry average.

In a fundamental analysis one would not make an analysis of the stock market or the stock’s behaviour. With a fundamental analysis you might find companies that are fundamentally strong i.e., have an excellent business performance, but whose stocks are currently undervalued by the market.

A technical analyst, on the other hand, sits on a lot of charts to infer patterns on how a stock is being traded. He employs complex statistical tools to study the graph of a stock’s price and its quantity traded over time. Out of all his efforts he expects the shape of the graph to tell us whether the stock price will rise or fall.

Such an analysis also looks for certain price levels in a stock’s performance in the past e.g., 52-week high and the 52-week low. These levels tell the highest and lowest price of the security for the past one year. The 52-week low is also called the support level because it is commonly believed to be the 'support' level below which the stock's price shouldn’t fall unless there is something fundamentally wrong with the company. But if it does, watch out, it can become worse.

In a technical analysis, analysts also look out for the average price of a stock which gives a good picture of the price trend minus fluctuations. A moving average of a stock is the average price of a stock over the past few days or months. Moving average prices, one for a short period and another for a long period, set the resistance levels or support levels for a stock. The first resistance or support level is the average price of the stock over a short period, say for the past 50 days. The second level is the average for a longer period, say for the past 200 days. The commonplace idea is that the resistance level resists the stock's or the market's efforts to go up for the time being and support resists the price from falling any further from what it already has.

If the current stock price is the same as the 52-week high, then obviously you should avoid buying the share at that price unless of course, you have inside information that it will go even higher! In case the stock breaks its resistance level with huge volumes, one might consider a buy after observing the stock movement for a day or two. The stock price ideally should increase steadily and positively. It should not fluctuate to a huge extent. A good stock should outperform the industry. Generally you should attempt to hold the market's top-performing securities -- those that have done better over the past year than the majority of stocks and expected to outperform even in the near future.

The basics of technical analysis are not too complicated for individual investors to try out themselves. Common market wisdom is that the stock market moves in discernible patterns and hence, technical analysis comes in handy by plotting graphs of recent and historic price movements and analysing them for trends.

Benchmarking a stock

Consider this: when you buy potatoes from your neighbourhood vegetable market, with a short survey you can ascertain what the prevailing rates for different qualities of potatoes are. The same becomes impossible when you go to buy stocks. Each stock has a unique price and unlike potatoes, cannot be clubbed as `a particular quality of stocks`. A good enough way to benchmark your stock is the market index. An Index is a composite of stocks that indicates how the overall market or a part of the market is moving. The grandfather of all indexes in India is the Sensex.

Is the Sensex sensual and sexy? That depends on whether it’s up or down, as the day’s headlines will tell you. And the excitement on the exchange waxes and wanes with the Sensex. As an index of the Bombay Stock Exchange (BSE), the Sensex includes the shares of 30 companies that are actively traded on the BSE. It is a weighted average of prices of the 30 select stocks where the weight is the market capitalization of individual stocks. These stocks are the ones that account for a large chunk of both the volume and value of shares traded on the exchange.

The Sensex is supposed to mirror the happenings on the BSE. Just as you check only a couple of mangoes in a basket to decide whether the entire lot is good, so will you check out the Sensex to get a sense of what is happening in the stock market. Being the oldest index in India it has also attained a position of pre-eminence in the minds of Indian investors.

The BSE has other indexes apart from the Sensex. The BSE National Index or the BSE 100 comprises 100 scrips (or stocks) listed on the BSE. Having a larger basket of stocks the BSE National Index enables a stable assessment of stock price movements. The BSE-200 comprises of the equity shares of 200 selected companies listed on the BSE.

Over the years foreign investors have shown eagerness in investing in India and many foreign financial institutions have also entered into the country. The Sensex and other indexes reflect the growth in market value expressed in rupee terms. The BSE-Dollex is a yardstick by which these growth values can be measured when the investment and the return are expressed in dollar terms. The Dollex is a dollar-linked version of the BSE-200 and hence also sensitive to the rupee-dollar conversion rate.

Similarly, the National Stock Exchange has an index, the S&P CNX Nifty. Since its inception this index, also called the Nifty Fifty, has attained great popularity among investors. Hundreds of calculations are made before 50 stocks of the NSE are selected for the index. S&P stands for Standard and Poor’s, a subsidiary of McGraw-Hill, and an investment advisory service that maintains one of the most widely followed benchmarks of stock market performance, the S&P 500 index. The CNX stands for CRISIL NSE Indices, the two companies that came together to form the index.

A market index is very important because one, it acts as a barometer for market behaviour, and two, it helps in benchmarking portfolio performance. For a particular category of mutual funds called the index funds, these indexes are used for passive fund management i.e. all a fund manager has to do to manage his portfolio is blindly follow the composition of the index.

The role of a good index is to reflect the state of the overall market at every moment and indicate how the stock market perceives the Indian corporate sector to fare.

Choosing Stocks

There are many theories and techniques about how to choose a winner, how to separate the wheat from the chaff. Some are homegrown, others are technically sophisticated. But beyond the jargon, there are three basic factors to look for while picking a stock:

  1. The company itself
  2. Its external environment
  3. The behaviour of its stock

What happens to the company affects the price of its shares on the stockmarket and, hence, your investment. The legendary investor Warren Buffet (incidentally, once the second richest man in the world) says that he never invests in a company whose business he doesn`t understand. As investors, we will do well to follow his practice.

So, knowing about companies is the first essential step in investment. You will need to know the business a company is in, and how is it doing both in absolute terms and in comparison to other companies in the same business. To do that, you have to look at the financial performance of companies and pick up the star performers. You will also need to look at the future of the business itself. Is it nearing the end of its life cycle? As investors, we hope to participate in a business with a lot of scope for growth.

We also need to look at the performance of the entire sector. Whatever for? After all, we aren`t investing in sectors. We`re putting our money in companies and we can get to know them by looking at their performance. Right? Well, look at it this way. Take your own profession. Doesn`t what happens to others in the same profession affect you too? If you are a banker and you see other banks laying off employees, you bet your last rupee you`ll start worrying whether your bank is the next in line to start downsizing. So, what happens in the banking sector concerns everybody with a stake in that sector.

Just like employees, investors too have a stake in the sector in which they have invested. As an investor, you wish to know the risks your company faces. These are of two types -- one that is peculiar to the company and can be controlled by it (called a unique risk), and the other which is more pervasive and often beyond the company`s control (called a systemic risk). We need to know about both kinds of risks to plan our investment strategy. For example, if the steel sector is not doing too well at the moment (a systemic risk), you may wish to move your investment out of a company in this sector.

A company operates within the broad framework of the economy. Its future is closely linked with the performance of the economy. This is due to the interdependence among various industries and sectors of the economy. Take the steel industry again. To do well, it needs a good demand for its products. Now, suppose the automotive industry or the construction industry is not doing well. Will that affect the steel industry? Of course, it will, because both automobiles and construction industries use steel. If these sectors are not doing well, the demand for steel will drop, affecting the performance of the steel industry. The indicators on the economy allow us to track general trends in the economy. If they don`t look very healthy, we ought to be cautious as investors.

Professional stock pickers adopt different processes to analyse stocks. Some adopt a method in which they begin at the general and then zoom in to the specific i.e. they would probably begin with an analysis of the economy. While analysing the present state of the economy they would look at interest rates, what economic outlook the finance ministry projects for the short term and other political events that might have a bearing on the economy. Having reached a conclusion about the economy, the professional will choose industries that he expects will perform well under the given economic conditions. Next, he hones in on some of the companies in the industry, sees how the companies are performing and then evaluates their stocks. The end product of such an analysis is to convincingly answer one question for his investors: Is the price at which the stock is currently selling worth it? The other method works in the reverse way in which the professional analyst picks up a stock, looks at the current and historic performance of the company, then studies the industry and finally takes an overview of the economy.

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