Advantages of Stocks

Returns from investments in shares come in two forms capital appreciation and dividends Capital appreciation takes place when there is an increase in the price of your shares. For example, if you buy 100 shares of XYZ Ltd. for Rs. 1,000 and later sell them for Rs. 1,800, there is a capital appreciation of Rs. 800 or 80 per cent. This is also referred to as capital gains or capital appreciation.

When you invest in shares, your capital grows quickly much faster than in most other forms of investment. Sometimes the growth can be spectacular, going even as high as 1,000 per cent per annum. People are attracted to shares precisely because they offer exciting possibilities of getting rich.

How much money can you expect to make from your investment in shares?

To answer this questiorr, let us look at the performance of five well known companies in the eight year period from I January 1996 to 31 December 2003 (See Table 1. 1). This period is long enough to cover every kind of economic mishap, and a number of booms and depressions. If you had bought shares worth Rs. 1,000 in each of these companies at their prevailing prices on 1 January 1996, the value of your investment of Rs. 5,000 would have multiplied by 23 times and grown to Rs. 1,15,308 on 31 December 2003 giving you a capital appreciation of 2,206 per cent. In other words, your capital would have grown at a compound rate of 48 per cent per annum. In addition, you would have also earned a substantial amount through dividends during this period,

Let us now turn to a comprehensive view of the returns from shares. In the last 26 years, the BSE Sensitive Index (Sensex) has appreciated by approximately 60 times giving an annualised compounded return of around 17 per cent. This kind of return is achievable by the average investor and outclasses the return that he can possibly hope to earn from real estate, gold, collectibles, bonds, etc. Table 2 gives an idea of what an average investor could have earned, and probably did earn, during the last seventeen years. The figures in Table 1.2 are based on the capital ap : preciation recorded by the BSE Sensitive Share Price Index.

We have found through experience that a reasonably intelligent and well informed stock market investor can, on an average, double his money in four to five years, or so. There are many who do even better. It all depends on how much knowledge and experience you have, and the time and effort you are prepared to spend on managing your investments.

Investments in shares enable you to keep well ahead of inflation. This is because share prices normally rise with inflation. By investing in shares you can ensure that the value of your savings does not get eroded over time by inflation. This is a big advantage that shares have over other traditional forms of investment, such as bank deposits, post office savings schemes, etc.

You get income too

Investments in shares not only give capital appreciation; it also gives income in the form of dividends. Dividend is the amount that a company distributes every year to its shareholders out of the profits it earns. It is usually expressed as a percentage of the face value of the share, or in rupees per share. To get a clear idea of what dividend means, let us assume that you own 100 equity shares of face value of Rs. 10 each in XYZ Ltd. Now if the company declares a dividend of 20 per cent or Rs. 2 per share, you will get a dividend of Rs. 200.

It is not necessary for a company to declare a dividend every year. Companies which make losses usually skip the payment of dividends. However, most profit earning companies usually give an annual dividend to their shareholders. Some companies even split this annual dividend into two instalments, called interim dividend and final dividend. Most Indian companies usually give dividends ranging from 10 per cent to 30 per cent. It all depends upon the amount of profits the company earns, and the policy adopted by its management on how much of these profits it can afford to distribute to its shareholders.

As a rule of thumb, the amount you are likely to get as dividends every year will normally be around I to 2 per cent of the market value of your shares. For example, if you have shares in various companies whose current market value is Rs. 50,000 then you can expect around Rs. 500 to Rs. 1,000 as the total dividend from these companies. This is a useful rule to remember. It comes in handy when you want to make a quick mental calculation on how much income you are likely to get by way of dividends on your stock market investments.

Investing in shares is not speculation

There is a common tendency to look upon the buying and selling of shares as speculation. Some people even goes to the extent of calling it gambling. This is simply not true.

When you buy a share after making a proper assessment of a company's future prospects, your risk is minimal and limited. When you do so on the basis of insufficient knowledge, incom¬ plete analysis, a "hunch" or a "feeling", the risks are naturally much greater. The former is investment, the latter speculation. Gambling is only an extreme form of speculation. The difference between investment and speculation really lies in the degree of risk that you are willing to accept for attaining your goal. The investor takes calculated risks and plays safe in return for moder¬ ate profits. The speculator deliberately takes high risks in the ex¬ pectation of getting disproportionately greater profits. In the stock markets, the speculator generally tries to make short term profits out of price fluctuations and usually ignores dividends. In addi¬ tion, he often plays around with borrowed money instead of using his own funds. On the other hand, an investor generally uses his own money, and buys shares with the intention of earning both long term capital gains and dividends. These are the essential differences between investment and speculation.

In the stock markets, both investors and speculators are operating all the time. However, it is not necessary that you should speculate. In fact, we strongly advise you against it. If you buy and sell shares on the basis of sufficient knowledge and analysis, your risks remain under control and your expected gains more predictable. In fact, in the stock market, long term investors very rarely lose any money at all, whereas speculators more often than not do. This book is written for investors. Its objective is to provide a new investor with the essential knowledge and techniques required for making a proper analysis before investing, so that risks are reduced and gains made more certain.

It is a liquid investment

A liquid investment is one which can easily be sold. If an investment cannot be readily converted into cash it is often worthless. Liquid investments also have other advantages. They give you a feeling of security because they enable you to change your mind and correct your mistakes in short, they give you flexibility for coping with the ever changing economic conditions.

Shares are one of the most liquid forms of investment. They are much easier to buy and sell than real estate or works of art. Investments in social security certificates, debentures, national savings certificates, fixed deposits in banks and companies are basically illiquid in nature, because they are made for a fixed period of time and cannot be readily converted into cash before the expiry of such period.

However, all shares are not equally liquid; some are more liquid than others. Real liquidity is only found amongst what are called "active" shares. Active shares are those in which transactions take place frequently on the various stock exchanges. These are about 1,500 or so in number, and constitute the most liquid forms of investment available in India today. If you confine your investments to these shares, as you should, you can ensure liquidity of your investment.

You can ensure the safety of your capital

Are, share investments safe? Do they provide adequate protection against the risk of a capital loss? They do, if you follow the three basic principles:

Liquidity,
Long term investment strategy, and a Diversification of your portfolio.
Liquidity ensures safety of capital because it enables you to convert your investment into cash at the slightest fear or hint of a capital loss.
A long term investment strategy protects your portfolio from the temporary fluctuations and vagaries of the market.

Di versification reduces the risk of a capital loss, by spreading your investment over a large number of companies run by different business houses, operating in different fields like chemicals, shipping, engineering, steel, paper, etc. and with plants located in different geographical regions of the country. The wisdom behind diversification of investments is the same as that expressed in the oft repeated aphorism "Never put all your eggs in one basket." By diversifying your investments you will usually find that even if you incur unexpected capital losses in one or two companies, these are likely to be more than adequately made up by gains in others.

It is easy to manage

Investments in shares are easier to manage and control than other forms of investment. Shares, being movable property, are easier to carry from place to place. Also, in case of loss, theft, or damage, you can easily obtain duplicate share certificates from the concerned companies. You don't need to keep share certificates in safes and bank lockers, or insure them like gold and jewellery. In the case of listed shares, investors in any case find it convenient to dematerialise their shares and keep them with a depository participant (bank, financial institution or broker). It is as easy and safe to keep shares in this form as keeping money in a bank. Managing share investments is much easier and less complicated than the management of property and real estate. You don't have to worry about problems, like property taxes, upkeep of buildings, and eviction of unwanted tenants.

However, there are a few things you will be required to do for managing your share investments efficiently. Apart from looking after your demat holdings and keeping track of dividends, you have to keep yourself reasonably well informed not only on the performance and working of the companies in which you own shares, but about other prominent companies also. This will en¬ sure that your buying and selling of shares is done at the right time and at the right prices. A list of newspapers, magazines, and other sources of investment information is given in Appendix A. You can also subscribe to investment newsletters and other investment advisory and counselling services to help you take correct and timely investment decisions.

You don't need a lot of money to start

The stock markets hold out attractive opportunities for the small investor because share investments do not necessarily require large sums of money. Investments in shares and the building of a portfolio can even be made with amounts as small as Rs. 100. Infact, most of the 50 million or so Indian shareholders are small investors with investments ranging from Rs. 10,000 to Rs. 50,000. Shares can now be bought even one at a time since the stock exchange authorities have now done away with the earlier concept of market lots and odd lots. This is a big advantage that investment in shares has over investment in property and real estate. The latter forms of investment require large sums of money and have now clearly moved beyond the reach of most middle class investors. Stock markets are also better organised and their working is more closely regulated by the government and Securities and Exchange Board of India (SEBI) than those of property or commodity markets, Even the activities of stockbrokers come under a closer watch than those of property agents, etc.

Again, investments in shares are ideally suited to the requirements of genuine middle class investors, as these don't involve transactions in "black" or unaccounted money. This is not always possible while buying and selling property and real estate.