WHAT IS SHARE MARKET? : A BEGINNER’S GUIDE

Two days ago, my 17 year old nephew Shantanu, got his Class XII CBSE and the Common Law Admission Test (CLAT) results. He has cleared the CLAT exam and has made the cut for two Institutes. I congratulated him and like a good Mama, asked him, “Beta what gift do you want from me?” Displaying wisdom beyond his years, he said, “I have requested my father to get a demat account opened in my name and I want you to gift me some shares in my account.” I was quite proud of him. Our discussions on the dinner table had had an effect on him. I said, “Done”.

The thumb rule in investments of any kind is earlier the better. This boy seems like a lambi race ka ghoda. But I want him to learn investing in stocks/shares on his own and not be spoon fed. Keeping in mind an utter novice who has no clue of shares I am writing this series on stock investing.

What is a share?  My sons Ayushman and Arjun want to start a business of selling burgers. The first thing they need is money or Capital. They have estimated that they need Rs 400,000 to start the business. Where can they get this money from? Or what is the Source of Funds? They have saved Rs50,000 of pocket money which becomes their seed capital. They approach their grandfather for a loan of Rs 300,000 which they intend to pay him back after 10 years with interest (Long term Debt). They ask me for a loan too, but seeing the potential in their business, I offer them the balance 50,000 but want to be a partner in their business. What I have offered, is to become a shareholder in their business. They contribute their Rs50,000 by purchasing 5000 shares which have a face value of Rs 10 for themselves and offer me also 5000 shares at face value.

The capital structure of the company A2Burgers Pvt Ltd will be some thing like this:-

Total No of shares fully subscribed and paid up                          10000
Equity or Share Capital (Number of sharesxFace Value)           Rs100,000
Long Term Debt                                                                                  Rs 300,000
Total Liabilities                                                                                    Rs 400,000

This amount of rs 400,000 would be utilised by the management of A2Burgers (P) Ltd to hire workers, buy machines, rent space, advertise, purchase raw material, pay bills etc and then they would sell burgers and then hopefully make a profit.

If the company makes a profit, I will also get profits in proportion to my capital i.e 50% and if the company makes a loss, I also lose money. So, a shareholder is taking a risk. If the business is profitable, he will gain and if it is loss making he loses. Whereas, Ayush’s grandfather who has given a debt to them has very little risk. Grandpa will get a fixed interest on his money and will get his loaned amount back after 10 years.

So, a share is a portion of a business bought by an individual. And the individual will be entitled to the profits or losses made by the company in proportion to the number of shares/shareholding in the company.

That is the fundamental truth of share market. When I buy a share of Asian Paints, I become a part owner of that  business. The business if selected properly will grow in five to ten years and increase profits. The profits will be shared with the shareholders. The price at which the share is sold in the market should ideally be related to the worth of the business, but market anomalies lead to under pricing or over pricing of the company. An astute shareholder reminds himself again and again till it becomes second nature to him that he is a business owner. And if his business is fine, he can ignore the quotes on the ticker tape given every second by Mr Market. In my next blog I shall cover PE ratio, EPS, BV etc.