How about comparing a share with a grocery store for a better understanding of a share and a share market? It is very common especially among beginners to have confusion, about what is a share and what is a share market. This article will help you gain clarity with a practical example.
Let me try to explain this using a very simple example and layman’s thinking, not making things complicated with financial terms and concepts.
Imagine you start a grocery store. Over a period of time, you have a regular set of customers and the store does well.
Assume you make a profit of INR 1 million every year by selling your products to your customers. Today, if a buyer asks you to sell the store to him.
For how much will you sell it to him in INR terms?
You certainly won’t sell it for 1 million which is just worth 1 year of your profit. Even 5 million to 10 million might be less given its 5 to 10 years of profit. If you continue with your store, you can make profits for the next 15-20 years, is what you might probably think. However, 15 million!
You might now start thinking that it is not a bad offer, as you are getting 15 years of profit immediately today, that your store would make upfront. You might try to negotiate for maybe 17 million (17 years of profit). Happily, take the money which your store might make over 15-17 years and retire. Hence the value of your store is INR 15 million, which is the price the buyer is also willing to pay and the seller is willing to sell.
Why is the buyer willing to buy at INR 15 million Now?
Any buyer will buy the shares with the expectation that the value of the business and so its shares will rise.
Probably the buyer sees the profit doubling from 1 million to 2 million, as customers increase, due to new townships coming up in the locality. So, the value of the store today will become 30 million instead of the current 15 million for which he bought, as the profit doubles.
Hence the value of the store will go up or down in line with the profit it generates.
Someone might want to pay 16 times the profit instead of 15 and here too the value of the store might go up.
This is a very simplistic explanation without accounting for Interest rates, discounted cash flows, etc.
In a stock market, many such stores in many sectors, are traded, where buyers and sellers meet. And prices go up and down like our example above based on many factors. However, the profits that the company generates, by and large, remain one of the most important factors in determining the value of a company.
This is the value at which, we as investors invest in stocks today based on the price at which it is available on the stock exchange after studying the financial positions and various other parameters of the Company.
Conclusion:
Shares of the Companies are like various stores on the stock exchange available to invest and the Share Market is a Recognized Stock Exchange.
When you are ready to invest, do reach out to me and I will help you manage your portfolio at [email protected]
Cheers,
Fund Manager Akalp Gupta,
Founder at StockInvest2Grow.com
What is a share?
A share is a unit of equity ownership in a company for all profits and/or losses of the company. Shares are offered for sale to the public to invite investments into the respective companies, to fund either expansion of the company’s existing business, or the development of new technologies within the company. The person investing in a company in exchange for a share is an investor, who can sell the stocks at any price in the future, as the company value goes up or down.
What is a Share Market?
The share market is a platform where different shares/stocks are sold or traded. It is a place for listed companies and is a recognized stock exchange. There are 24 recognized stock exchanges in India.
As and when trades are conducted, prices rise or fall. As the demand for the stock increases, there are more buyers of that particular stock, which leads to an increase in the price of the stock, and when a company starts selling a particular stock without many takers, the price falls.
What are the types of Shares?
Equity Share and Preference Share
What are the types of Equity Share based on Share Capital?
Authorised-Maximum amount of capital that can be raised by issuing equity shares
Issued- Specific portion of the authorized Capital offered to investors
Subscribed- Portion of issued shares subscribed by investors either wholly or partially.
Paid-Up Share Capital-Amount of money actually paid by the investors
What are the types of Equity Share based on Definition?
Bonus -Additional shares issued to existing shareholders
Right Issue-New share issue to the existing shareholders
Sweat Equity-Reward to an employee for significant contribution to the company
Voting & Non-Voting Shares-Shares carrying voting rights and not carrying voting rights
What are the types of Equity Share based on Returns?
Dividend -Distribution of profits on a pro-rata basis
Growth-Exponential growth increases the value of such companies
Value shares-Traded at a lower price
What is a Preference Share Capital?
Preference Shareholders receive preference in profits distribution as compared to equity shareholders.