This article is written by Ria Dalwani, a student of Symbiosis Law School.
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years” – Warren Buffet
Current market trends and analysts suggest that the bull run for the Indian markets will continue this year. While many of us have been conditioned to invest in safer options with minimal risks and guaranteed returns such as fixed deposits, we fail to acknowledge the consequence of inflation chewing into our investments. To generate wealth from income, it is vital to understand and utilize the present resources for future gains. Money kept idle is money diminishing in value. That being said, while it is important to invest, it is equally important to hedge losses.
An investor should plough his/her funds in bonds, commodities, gold, mutual funds, real estate, shares etc. only after carefully studying every facet. A new investor must chalk out an investment plan that reflects logical thinking, long term planning, independence and a realistic goal. A new investor, should note that investing in the stock market is risky, avoid plugging money in one stock, spread risks, study the company before investing and opt for long term investments over short term trading. Buy low and sell high is the ideal trading mantra. However, to follow this mantra an investor needs to plan, research and study.
You are the driver of your own destiny. Remember, there is a difference in being invested and being well invested. With the manifold increase in startups, the spending power of the younger generation has multiplied. Subsequently, many young entrepreneurs have turned potential first time investors in direct equity. ‘Where to invest’ and ‘when to invest’ is an independent choice you have to make. ‘How to invest’ is a question we can answer for you!
DIRECT EQUITY INVESTMENTS
The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are the two pillars of the Indian Stock Market. The BSE’s Sensitive Index (SENSEX) and the NSE’S S&P CNX Nifty are the stock indices. The SENSEX is the oldest index for equity. An equity share is a unit of ownership in a company. The concentration of an equity shareholder’s ownership in the company increases when the number of shares held by the equity shareholder increases. Equity, also known as shares or stocks should constitute a part of an investor’s portfolio and not dominate the entire portfolio.
INITIAL PUBLIC OFFER
An Initial Public Offer (IPO) is when a company offers its equity shares to the public for subscription for the very first time. Selling shares to the public is a common route to raise capital for funding operations and expansion. In a primary market, a company raises capital by floating its shares for subscription, through an IPO. This is called a primary issue because the subscribers purchase the shares from the company itself. A private company converting to a public company and even a new company can make an IPO.
The company has to submit a prospectus to the Securities Exchange Board of India (SEBI) before making an IPO. Once, the company meets all the compliance requirements it can open the IPO.
Before investing in an IPO, the investor must thoroughly study the company to make a healthy investment. To carefully study a company, one has to invest time, dedication and patience. Being an educated investor is the most important prerequisite. An investor must assess the business plans, financial health, promoters’ background, market expectations and risks involved.
A Book Building process is when the company making an IPO fixes a price band. Thereafter, investors are invited to bid within the set limits of the price band. However, the difference in the upper limit and the lower limit of the price band cannot exceed twenty percent. The bids made by investors, demonstrate the demand for the stocks. These bids are then used to set the cut off price or offer price for the stocks. The share price determined from the bids within the price band is the cut off price. Usually the price at which the maximum number of bids are made is deemed to be the offer price. In the event that an investor had bid at a higher price than the offer price, the company will return the difference to the investor. Investors (retail investors) who would like to buy the stock at the cut off price will mark the cut off price option in the application form.
Allotments of the shares are made to the public. A common question that arises is “What happens if there is over subscription?”. Over-subscription occurs when the number of shares being demanded is much more than the number of shares available. In this case, the company will allot shares on a pro-rata basis and refund the money to the investors when no allotment is made.
THE PROCEDURE TO INVEST IN AN INITIAL PUBLIC OFFER
Step 1- Demat Account
Dematerialization is the conversion of physical certificates into securities in an electronic form, which are credited to the investor’s account. The certificate must be in the name of the investor for dematerialization to process.
In an IPO shares are issued in a dematerialized form. Hence, a demat account with a depository participant has to be opened. A depository holds shares in an electronic form like a bank holds money. Depository participants are legally authorized to open demat accounts and to act as a middlemen between the investor and the depository. The depository participant must be registered. Depository participants are agents of the depository and they charge an annual depository fee, holding fees etc. Additionally, depository participants charge a fee on a per transaction basis as well. The National Securities Depository and the Central Depository Services monitor the dematerialized securities.
The following documents and details are required to open a demat account-
- Address proof
- Identity proof
- Bank account details
- Nominee details
Step 2 – Application Form and Allotment Money
An application form needs to be filled. These forms are available with brokers, financial companies, distributors, mutual funds etc. If you have setup an online transacting account you can submit your application online as well. The application form will include a list of collecting bankers. The form along with the application money and allotment money has to be deposited with the collecting bankers.
Step 3- Allotment of Shares
The company will make the allotment of shares after the issue has closed.
Step 4 –Listing on the Stock Exchange
Following, the IPO, the company is listed on the stock exchanges to start trading in the secondary market. The company will make an announcement of the listing date. The price of shares on the first day of the listing will be determined after considering the demand for the company’s shares in the market.
Dividends and Tax Payments
The returns to an investor can be in the form of dividends and/or capital gains. Firstly, dividends earned on shares are TAX FREE. Secondly, shares sold after one year of purchasing the shares is also free from long-term capital gains tax. However, shares sold within one year of the issue are subject to short-term capital gains tax. Thus, formulating an investment plan is crucial for the decision making process.
Once an investor becomes a shareholder of the company, he/she is eligible to subscribe to bonus shares and rights shares of the company as well. Bonus shares are shares allotted to existing shareholders at no cost. The cost of purchasing bonus shares is nil. Rights shares are a benefit given to existing shareholders wherein shares are allotted at a discount to the existing market price. Rights issues are offered to the shareholder depending on the number of shares held. In the event that the existing shareholder does not wish to purchase the rights shares he can sell his right by charging a price in addition to the actual price of the shares.
SECONDARY MARKET INVESTMENTS
In the secondary market the regular trading of the company’s shares begins. The shares are bought from the existing owners of the shares and not directly from the company. Hence, the buyer purchases the shares from a person who already owns the shares of the company. Trading in the secondary market is buying and selling of shares of a listed company. The buying and selling of shares is facilitated through a stockbroker or an online trading portal.
PROCESSING A SECONDARY MARKET TRANSACTION
Step 1- Demat Account
A demat account with a depository participant has to be opened. The depository participant must be registered. An investor can opt for a “Three in one” demat account which operates as a demat account, bank account and broking account. Thus, all three accounts are opened with the same entity to simplify the transaction.
Step 2- Register with a broker
A stock-broker can be a physical broker/ offline broker or an online broker. After choosing the broker, registering with the broker is necessary. An offline broker must be personally contacted, either physically at his office or on the phone. An online broker allows trading without personal contact. At the outset, it is recommended that first time investors opt for offline brokers.
Step 3- Trading
A settlement cycle is the time period between placing the order for shares with the broker and actually receiving the shares in the demat account. Similarly, while selling the shares, it is the time between the order to sell shares and actually receiving the payment in the seller’s bank account. Presently, the settlement period is such that actual receipt of shares or payment occurs on the second business day.
Investors can opt for marginal trading wherein money is borrowed from the broker to buy stocks. This is an intraday trading, as the investor has to repay the broker on the same business day irrespective of whether the investor made a profit or loss. Marginal trading is risky and has often backfired on investors.
Stop loss order is a mechanism to hedge losses wherein an investor can book an order with the broker to sell the shares if the market price falls to a particular price. This price is called trigger price and it cannot exceed the price of the stock. The trigger price can be changed in the event that the price of the stock rises.
While trading online, the shares can be purchased at the prevailing market price by placing a market order. In the event that the investor wishes to transact (buy or sell) at a particular price, a limit order can be placed setting the price of the stock at which the transaction should be processed.
To trade in the secondary market-
Firstly, the buyer pays his broker money to buy the shares.
Secondly, the broker hands over this money to the stock exchange.
Thirdly, the stock exchange pays the money to the seller’s broker.
Lastly, the seller’s broker hands over the money to the seller and the seller gives his shares to the broker.
Dividends and Tax Payments
In the secondary market, returns in the form of dividend are TAX FREE. On every transaction made on the stock exchange, a Securities Transaction Tax (STT) is levied. Service Tax (ST) is levied on the brokerage fee and is calculated on a per share basis. Shares sold after one year of purchasing the shares is free from long-term capital gains tax. Shares sold within one year of the issue are subject to short-term capital gains tax.
There is no perfect time to start investing. An investment decision should not be based on market tips and speculation. Avoid investing in a company merely because the stock prices of a particular company are increasing exponentially, the buy high sell higher approach rides on a high risk factor. Invest in a company because you believe in its business plans, you have studied its financial records and you have assessed its future prospects.
To, all the young entrepreneurs- expertise does not come with age, it comes with experience! Happy Investing!