Tuesday, July 15, 2008

Investment in shares

In my previous post on banking, I mentioned that by depositing in bank or in shares or mutual funds, we can multiply our money. This is possible in banks, as we acquire interest for the money we deposit. But what about, shares?

Shares - This is belonging of a public limited company that we can buy by paying some amount. To be more clear, we have the money earned by us. Let us assume there is a company, whose worth is Rs.10000. The company needs Rs.5000 urgently. It can either get by borrowing from bank (called as debt financing) or from the public, by offering shares (called as equity financing). The company wishes to sell half of it to the public. So it announces 500 shares, each costing Rs.10. This is called the face value of the share. This first offering by the company is called as Initial Public Offering or IPO.

So I wish to invest my money in this IPO. I wish to invest Rs.200 in the company's shares. So I will get 20 shares. This 20 shares is 4% of the company's share. So I am one of the owner of the public limited company. My ownership percentage is 4%.

The price range of the company's share is controlled by SEBI (Security and Exchange Board of India) in India. The key index is the SENSEX that is operational at the Bombay Stock Exchange. Depending upon the buy or sell call initiated by investors on the company's share, the price will rise or fall. If the price of the share increases to Rs.15 on some other day and then, if I wish to sell my 20 shares, I can do it. There by I will get Rs.300. That is a profit of Rs.100. Thats great right?

But now a days these transactions are taken care by intermediate parties called brokers, who will buy or sell shares for us. So for every transaction we need to pay them some amount. So taking the brokerage into consideration, we need to decide on selling the share.

For example, if a broker charges 10% (10% of 300), we will get only Rs.70 as profit from the above example. Also we may need to pay the broker, some amount for buying a share. In the above case, we need to pay Rs.20 for Rs.200 to be invested in a company.

So actual profit will be Rs.50.

Cost of share - 200
Borkerage - 20
Total (from our hand) - 220

Sold for - 300
Brokerage - 30
Total (received by us)- 270

Net profit = 270 - 220 = 50

If I had sold the share when its price has been Rs.20, I would have got an amount of Rs.400. Subtracting brokerage of Rs.40, There would be a profit of (360 - 220 = 140).

Also we will get some amount as dividend from the company. Suppose the company records a profit of Rs. 1000, this amount is divided based on the proportion of shares held by the investors and given to them. The company will declare that it will give some amount for each share held by the investor. For example, if it says that it will give Rs.1 for each share held, I will get Rs.20 as dividend in this case.

Thus we can earn in share market.

The difference between share market and bank is the steady return. We can get fixed amount as interest from bank. If a bank says 8% per annum as interest, I will get Rs.8 as interest if I had deposited Rs.100, at the end of one year. So I will have Rs.108/-. This will be steady.

But in share market, I may get profit if the company performs well. If it under performs, I have the risk of losing the money that I had invested. In the same example, if the price of the company's share falls to Rs.8, The value that I may get on selling is (20 x 8 = 160). Brokerage will be Rs.16. So Net amount that I will get is Rs.148. But I have invested Rs.220 (including brokerage). So I am reporting a loss of (220 - 148 = 72).

This is a speculation. We need to take risk and multiplying money needs lot of analysis.

1 comment:

shiva said...

Super Saranya! I have never been enlightened so well on finance :)

Keep writing...!