Complete Guide to Shares & Stock Market
A deep dive into the meaning, types, mechanics, and strategies of equity investment.
1. Meaning and Definitions of Shares
In the corporate world, capital is the lifeblood of any business. However, for large-scale operations, a single individual often cannot provide all the necessary capital. This is where the concept of "Shares" comes into play.
Meaning: A "Share" represents a unit of ownership in a company. The total capital of a company is divided into small, equal units. Each such unit is called a share. When an individual buys a share, they become a part-owner of the company, proportional to the value of the shares they hold.
For example, if a company has a total capital of $100,000 divided into 10,000 units of $10 each, each unit of $10 is a share. If you purchase 100 shares, you own $1,000 worth of the company's capital.
Formal Definitions
- General Financial Definition: A share is an indivisible unit of capital, expressing the ownership relationship between the company and the shareholder.
- Legal Perspective: In many jurisdictions (like under the Companies Act), a "share" is defined as "a share in the share capital of a company and includes stock." It is a movable property transferable in the manner provided by the articles of association of the company.
2. Objectives of Issuing Shares
Companies do not issue shares randomly; there are strategic financial objectives behind this process. The primary reasons include:
- Raising Long-term Capital: Unlike bank loans which must be repaid with interest, share capital is generally permanent capital that does not need to be repaid during the lifetime of the company (except in cases of buybacks or liquidation).
- Business Expansion: To fund new projects, build new factories, or enter new markets, companies require massive funds that are best raised through equity.
- Debt Repayment: Companies often issue shares to pay off high-interest debts, thereby reducing their financial burden and improving their balance sheet.
- Corporate Restructuring: Shares are often used in mergers and acquisitions where a company pays for the purchase of another company using its own shares instead of cash.
- Employee Motivation: Through ESOPs (Employee Stock Option Plans), companies issue shares to employees to retain talent and align their interests with the company's growth.
3. Nature of Shares
The legal and financial nature of shares is distinct. Understanding these characteristics is crucial for any investor.
Shares are considered movable property. They can be bought, sold, gifted, or transferred from one person to another, much like a car or furniture, subject to the regulations of the company's Articles of Association.
Each share (unless held in dematerialized/electronic form) has a distinctive number which distinguishes it from other shares. This aids in tracking ownership and history.
A share is not just a piece of paper; it represents a bundle of rights (right to vote, right to dividend) and liabilities (limited liability to the extent of unpaid value).
Key Characteristics:
- Liability is Limited: The liability of a shareholder is usually limited to the face value of the shares. If the shares are fully paid up, the shareholder has no further liability, even if the company goes bankrupt.
- Evidence of Title: A share certificate (or electronic entry in a Demat account) is the prima facie evidence of the title to the shares.
- Part of Share Capital: It is a fraction of the share capital and forms the basis of the ownership structure of the company.
4. How Shares Work
The lifecycle of a share involves the Primary Market (creation) and the Secondary Market (trading). Here is a visual representation of the flow.
The Lifecycle of a Share
Company forms and authorizes capital.
Company offers shares to public for the first time.
Shares are listed on Stock Exchanges (NSE, BSE, NYSE).
Investors buy/sell shares daily. Price fluctuates.
Mechanism Explained:
When a company needs money, it launches an Initial Public Offering (IPO). Investors bid for these shares. Once allotted, the shares are listed on a stock exchange. From this point on, the company does not participate in the daily buying and selling; instead, existing investors sell to new investors. The price is determined by demand and supply forces. If more people want to buy, the price goes up; if more want to sell, the price goes down.
5. Returns on Shares
Why do people invest in shares? The potential for high returns. Returns come in two primary forms:
A. Capital Appreciation
This is the increase in the market price of the share over time. If you buy a share at $100 and sell it at $150, the $50 difference is your capital appreciation or capital gain. This is driven by the company's growth, profits, and future outlook.
B. Dividend Income
Dividends are a portion of the company's profits distributed to shareholders. It is not mandatory for companies to pay dividends, but established profitable companies often do so to reward shareholders. It provides a steady stream of income independent of the share price movement.
C. Bonus Shares
Sometimes, instead of cash dividends, companies issue free additional shares to existing shareholders. For example, a 1:1 bonus means for every share you hold, you get one extra share for free.
6. Rights of a Shareholder
Ownership comes with privileges. Being a shareholder grants you specific legal rights:
- Voting Rights: Equity shareholders have the right to vote on corporate matters, such as appointing directors or approving mergers, usually at the Annual General Meeting (AGM).
- Right to Dividends: If a dividend is declared by the company, the shareholder has a right to receive it.
- Pre-emptive Rights: If the company issues new shares, existing shareholders often have the first right to buy them (Right Issue) to maintain their percentage of ownership.
- Right to Information: Shareholders can inspect the company's statutory registers and receive annual reports and financial statements.
- Residual Claim: In the event of liquidation (closing down), shareholders have the right to claim the remaining assets after all creditors and loans have been paid off.
7. Types of Shares
Shares are broadly classified into two main categories: Equity Shares and Preference Shares. However, there are nuances within these categories.
| Category | Sub-Type | Description |
|---|---|---|
| Equity Shares | Ordinary Equity Shares | The most common type. Carries full voting rights and ownership. Returns fluctuate with company performance. |
| Shares with DVR (Differential Voting Rights) | These shares may offer higher dividends but fewer voting rights, or vice versa. Designed for promoters to retain control or passive investors looking for income. | |
| Sweat Equity | Issued to employees or directors for their "sweat" (hard work) or intellectual property rights, usually at a discount. | |
| Preference Shares | Cumulative | If the company skips a dividend in a bad year, it accumulates. The company must pay all arrears before paying equity shareholders. |
| Non-Cumulative | Dividends do not accumulate. If missed, they are lost forever. | |
| Convertible | These can be converted into equity shares after a specific period. | |
| Redeemable | The company repays the principal amount to shareholders after a fixed period. |
Detailed Explanation of Preference Shares
Preference shares are a hybrid instrument. They resemble debt because they pay a fixed dividend rate (like interest), but they are legally equity. They are called "Preference" because:
- They have a preferential right to receive dividends before equity shareholders.
- They have a preferential right to be repaid capital in case of company liquidation.
However, preference shareholders usually do not have voting rights.
8. Difference: Shares vs. Stock vs. Market
While often used interchangeably, these terms have distinct technical meanings.
Share vs. Stock
Share: Refers to the smallest unit of ownership in a specific company. (e.g., "I own shares of Apple").
Stock: A more general term used to describe ownership certificates of any company or a collection of shares. (e.g., "I own stocks" implies a portfolio). In British law, "Stock" can also refer to fully paid-up shares consolidated into a single fund.
Share Market vs. Stock Market
Effectively the same thing. It is the physical or digital infrastructure where shares of public companies are issued and traded. It facilitates the exchange of securities between buyers and sellers.
9. Who are Shareholders?
A shareholder (or stockholder) is any person, institution, or company that owns at least one share of a company's stock. They are the owners of the company.
- Retail Investors (Individual): Regular people investing their personal savings.
- Institutional Investors: Large organizations like Mutual Funds, Pension Funds, Insurance Companies, and Hedge Funds that invest vast sums of money. They often have significant influence over company management.
- Promoters: The founders or original owners who hold a controlling stake in the company.
- Foreign Institutional Investors (FIIs): Investors from outside the country investing in the domestic market.
10. Where and How to Buy Shares?
You cannot walk into a company's office and buy shares. You must go through the secondary market ecosystem.
Where to Buy? (The Platforms)
Shares are bought on Stock Exchanges. The most famous ones include:
- NYSE / NASDAQ (USA)
- LSE (London)
- NSE / BSE (India)
- JPX (Japan)
How to Buy? (The Process)
Step-by-Step Investment Journey
- Step 1: Find a Broker. Select a registered stockbroker (Full-service or Discount broker).
- Step 2: Open Accounts. You need three things:
- Bank Account: To hold your money.
- Trading Account: To place buy/sell orders.
- Demat (Dematerialized) Account: To store shares in digital format.
- Step 3: Link Accounts. Transfer money from your Bank to your Trading account.
- Step 4: Place Order. Log in to the broker's app/web portal, search for the share, enter quantity and price, and click 'Buy'.
- Step 5: Settlement. The exchange verifies the trade. Shares are credited to your Demat account (usually within T+1 or T+2 days).
11. Risks and Challenges
Investing in shares is a high-risk, high-reward game. "Caveat Emptor" (Buyer Beware) applies strongly here.
- Market Risk (Volatility): Share prices fluctuate wildly due to news, sentiment, or global events. You can lose a significant portion of capital quickly.
- Liquidity Risk: In smaller companies (penny stocks), you might not find a buyer when you want to sell.
- Company Risk: If the specific company performs poorly, declares bankruptcy, or faces a scandal, the share price can crash to zero.
- Regulatory Risk: Changes in government policies, taxes, or industry regulations can negatively impact sectors.
- Inflation Risk: If returns from shares do not beat the inflation rate, the real value of your money decreases.
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