History & Basic Terms Of Stock Markets

I will try to keep my language as simple as possible.

Lets start with the definition of Stocks.

A Stock is a share in the ownership of a company. When someone is holding a stock, it means that he/she has a claim on company's earnings as well as assets. The number of shares owned by a person, represents level of ownership in the company. The more number of shares you have, higher is your ownership in the company. Shares, equities and stock represent the same thing as described.

Holding a share in the company means you have right to every thing that company owns, of course, depending on the % of your holding. You also have voting rights in any decision taken by the company related to stock. With the levels of investments that a retail investor does, we hardly think of this.

Ofcourse, we dont have to misunderstand this. Being a shareholder of any Tata Company, doesn't mean you can advice Ratan Tata on how to run his company, or get any products of the company for free. The maximum right a shareholder can have is that, he/she can vote in the meeting where a decision is being taken to select the board of directors.

In modern fast paced world, people seem to have forgotten the actual meaning of holding shares in the company, because everything happens electronically through internet, and no one is bothered about the hard copy in form of stock certificate. Below the image of how a stock certificate looks like.

Imagine the world where, when a person wanted to buy a share,  he/she had to visit a brokerage firm and execute his order, and after that, company gave him/her the certificate of his holding. Similarly, when one wanted to sell, he/she had to visit the brokerage firm again with the certificate and then get his/her shares sold.

Its very difficult to imagine these things today, as we live in the world where everything happens with one mouse click or a phone call.

1) Why a company issue stocks?

Lets say we are running an organization, and we are in need of money. We have 2 options. Either we can take a loan from bank in form of debt, or we can raise money from common people by issuing stocks, which is called equity. Generally the management of the company prefers issuing stocks because, in case, where we take loan from the financial institute, we need to repay it back along with interest, where as that is not the case with equity. The only thing that a company repays, is the possibility or hope that someday, people will get more than what they paid to buy shares.

The first time when a company comes up with the sale of shares, where they issue the same to public, is known as Initial Public Offering (IPO)

Being a shareholder in the company, we are ready to take a risk, because the price of the stock may go up and down depending on the performance of the company. Even if the company goes bankrupt, we, as a shareholder get the last priority in terms of repayment. All the debts taken from financial institues, like we have seen above, has to be paid first. If still they have anything left, shareholders will be paid, but practically, this is never the case. If the company goes bankrupt, accept the fact that you have lost all your money. This is the risk involved in investing in shares.

This is the negative side that we have seen. But look at the positive side. Investing in right stocks has given unbelievable returns, in the past to many shareholders, which one cant even dream of getting through investment in Banks or Bonds.

2) Types Of Stocks:

There are 2 basic types of stock:

a) Common Stock: A stock/share/equity as discussed so far refer to common stock. As  discussed above, the common stock can reward you maximum, among all the other investments. But at the same time, risk associated is also maximum, in case where company is unsuccessful or goes bankrupt. Common stock holders may also get rewarded with dividend, but it is not mandaory, to pay dividend to common stock holder, It depends on the organization to take that decision.

b) Preferred Stock: Preferred stock holders have higher priority than Common sock holders. Preferred stock holders are generally guaranteed a fixed dividend forever. As we have seen the case of bankrupcy earlier, preferred stock holders are paid off before common stock holders. If the company wants, it can purchase back the preferred stock anytime by giving premium to the holders. Investment in preferred stock is kind of investing in between stocks and bonds.

3) How Stock Trades:

Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. The other type of exchange is virtual, composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing.

Market can be of 2 types. The primary market is where securities are created (by means of an IPO) while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies. The secondary market is what people are referring to when they talk about the stock market. It is important to understand that the trading of a company's stock does not directly involve that company.

4) Few Basic Market Terminologies:

a) Market Capitalization:

It is the measurement of size of the business enterprise, which is equal to the share price times the number of shares outstanding of a publicly traded company.

Market Capitalization = Number Of Shares Outstanding * Current Price Of Each Share

b) Earning Per Share (EPS):

The portion of company's profit allocated to each outstanding shares of the common stock. It serves as a indicator of company's profitability.

EPS = (Net Income - Dividend on Preferred stocks) / Number of outstanding shares

c) Price-Earning Ratio (P/E):

A valuation ratio of company's current share price compared to its per share earnings.

P/E = Current Market Price / Earning Per Share (EPS)

d) Cash EPS:

A measure of financial performance that looks at the cash flow generated by company on a per share basis. This differs from basic EPS, which looks at the net income of the company on per share basis. The higher a company's cash EPS, the better it is considered to have performance over a period. A company's cash EPS can be used to draw comparisons to other companies or to the company;s own past resut.

Cash EPS = Operating Cash Flow / Diluted Shares Outstanding

e) Gross Profit Margin (GPM):

It is the ratio of gross profit to sales. Consider a compnany with Rs 100 as Sales and Rs 10 as cost of capital goods sold. The gross profit would be 90 Rs and hence the GPM would be 90%. A higher GPM compared to others in same industry indicates either or both of the 2 possibilities, higher realisation on each unit sold and the ability to source raw material at lower cost.

f) Operating Profit Margin (OPM):

It shows the impact of operating cost on a company's profitability and is calculated as operating profit divided by sales. A high operating cost affects the OPM. In the above example, if the operating cost other than cost of sales is 50 Rs, the operating profit would be Rs 40 (90-50) and the OPM would be 40%. If OPM increases over time and GPM remains same, it indicates improvement in operating efficiency.

g) Net Profit Margin (NPM):

It shows how much a company saves after meeting all its expense. So, and NPM of 20% would mean that company is able to save 20 Rs, per sales of 100 Rs, after meeting all its expenses. If company's NPM increases over time and OPM remains same, it indicates reduction in non-operating expenses such as taxes and the interest outgo.

Source: Investopedia


  1. Dear Kunal,
    Pls.let me know where we see the company is debit free in the annual report.

    Harjeet Singh

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