Things To Remember While Investing in Stock Market

Introduction

In this article, we are going to discuss in detail the 5 golden rules for stock market investments which the investors should adhere to.

An assured formula has yet to be discovered for acheiving the success in stock market. Still here are some golden rules which, if followed prudently by the investors, may increase their chances of getting a good returns from the stock market.

5 Golden Rules of Stock Investments

Rule 1 : Invest in Business Which You Understand

• The approach for stock market investment should be a business oriented and not the specific stock oriented. In simple words, an investor should invest in business instead of merely focusing on the stocks.
• The investor should invest in those businesses which they understand. The understanding of the business of the company is very important before investing in that stock.
• In order to be successful investors, we must acknowledge that there are some types of companies we understand, and some we do not understand, and then we must only invest in what we understand.

Rule 2 : Never try to Time the Market

• An investor should never try to time the market. Nobody has ever done this successfully and consistently over multiple business or stock market cycles.
• Catching the tops and bottoms is just a myth. Timing the market, is a false notion or misconception till today and will remain the same in the future also. In fact, many people have lost far more money than people who have made money in the attempt of timing the market.
• However, a majority of investors, do just the same thing ie. they keep on trying to time the market. And thus they lose their hard-earned money in the process.
• So a prudent investor should never try to time the market. In the long-run, Time in the market is far more beneficial as well as significant than timing the market. An investment should spend more time in the volatile market to give the maximum returns for the investor.

Rule 3 : Avoid Herd Mentality

• The typical buyer’s decision is usually highly influenced by the actions of his associates, colleagues, or relatives. Thus, if everybody around is investing in a particular stock, the tendency for potential investors is to do the same. But this strategy is bound to go wrong in the long run.
• Investor should strictly avoid having the herd mentality if he don’t want to lose his hard-earned money in stock markets.
• One should always remember the key lines of Warren Buffett – “Be fearful when others are greedy, and be greedy when others are fearful!”

Rule 4 : Keep Realistic Expectations

• Investors should keep realistic expectations from their stock investments. We should never enter into the stock market by keeping 30%-40% returns expectations. There is nothing wrong with hoping for the ‘best’ from your investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions.
• For Example, lots of stocks have generated more than 50% returns during the great bull run of recent years. However, it doesn’t mean that you should always expect the same kind of return from the stock markets.
• Expectations from the equity investments should very rational. What do we mean by rational expectations? Rational expectations towards equity investments should be equal to (current GDP % + 5%). We should plan our financial planning goals according to this realistic returns expectations.

Rule 5 : Follow A Disciplined Approach

• Volatility comes hand-in-hand with a great bull runs in the stock market, resulting into the cycles of panic moments also. The volatility witnessed in the markets has inevitably made investors lose money despite these great bull runs.
• However, the investors who put in money systematically, in the right shares and held on to their investments patiently have been seen generating outstanding returns.
• Discipline in investing is about forming good habits and then doing them consistently. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long-term broad picture in mind.

Difference Between Bonus Share & Stock Split

In this article, we are going to do a comparative analysis of Bonus Share Vs Stock Split. There is always a lot of confusion among investors regarding bonus shares and stock splits, as both results into an increase in no. of stocks and a decrease in share price.

We have discussed what is bonus share and what is stock split in detail in our earlier articles.

Bonus Share Vs Stock Split Comparison

Following are the main differences between bonus share and stock split :

1. Meaning

• Bonus share is a free additional share for the shareholder. Giving bonus shares is a way of distributing the corporate’s earning to the shareholders, not given out in the form of dividends but converted into free shares. The capital is simply being transferred from the retained earning account to paid up capital account, so the total shareholders equity remains same.
• Stock split is the same stock split into more shares. Stock split is just splitting of stock and do not involve any change in balance sheet, just the no of shares will increase.

2. Example

• Bonus Share : If a shareholder holds 100 shares of a company and a company declares 4:1 bonus, that is he gets 4 shares for free, for every one share he holds. That is total 400 shares for free and his total holding will increase to 500 shares.
• Stock Split : A stock split of 1:10 means that a shareholder will have 10 shares for every single share he holds. The same single share held by the shareholder is divided into 10 smaller shares.

3. Objective

• Bonus Share : To distribute the company’s accumulated earnings to the shareholders without paying dividends, but in the form of free shares. So, the company can use the cash for expansion projects. To improve the creditworthiness, thereby credit rating of the company. Thus, bonus share is issued to maintain and nurture the brand value of the company.
• Stock Split : To increse the affordability of stock for the small retail investors which can result into the increased investor base. To enhance the liquidity of the stock in the market.

4. Face Value

• In case of bonus issue, there is no change in the face value of the stock.
• In case of stock split, the face value changes. For example, for the stock split of 1:10, the face value of Rs.10 for a stock will become Rs.1 after the split.

5. Share Capital & Reserves

• In case of Bonus share issue, the share capital increases but the reserves gets reduced proportionately. So, the balance-sheet statement of the company changes accordingly.
• While in the case of stock split, the share capital and reserves remains the same. Instead, the number of shares is doubled and the par value of the stock is halved. Thus, there is no change in the balance-sheet statement of the company.

6. Who Are Benefited?

• Bonus Shares are available only to the existing shareholders.
• Both existing shareholders as well as potential investors can be benefited from the stock split.

7. Impacts

Lets compare the impact of these events from the market perspective.

• Bonus issue will make the shares more affordable, but bonus issue is more of a confidence statement by the company, indirectly indicating continued better prospects.
• On the otherhand, stock split will only make the shares more affordable for retail shareholders and there could be some marginal effect on the demand for shares going forward.

Impact on Future Dividends

• Generally, the company’s dividend outgo increases on account of bonus issue. Because the dividend is always declared on face value. As we have seen in the above points face value of share doesn’t change in case of bonus share issue. So the shareholders get the additional dividend on each bonus share received.
• While, in case of stock split, the face value of the share decreases according to the split ratio. As a result, whenever the company announces dividend in future post split, the dividend is going to be calculated as a decided % on the reduced face value of the share. The existing shareholders won’t get impacted due to it since even if face value of the share is decreased, the number of shares increases in the same ratio. so the total dividend received would be the same. But for the potential or new investors post split, the proportion of future dividends to be received would get affected adversely.

Tax Treatment on Gains on Bonus Share Vs Stock Split

• One major difference is in terms of the tax treatment of the gains in both the cases.
• In case of bonus issue, the new shares are received at price of zero, so when calculating the capital gains this will affect the tax treatment (whether each lot is treated as a short-term or long-term gain.
• While in case of stock splits, the stock price gets halved so the cost-basis of the gain/loss will also get halved.

Significance of Stock Split

Introduction

A stock split is a corporate action in which a company divides its existing shares into multiple shares to boost the liquidity of the shares. Let us discuss what is stock split, why it is done, what are the impacts and the significance of stock split from company’s as well as investors’ perspective etc.

What is Stock Split?

• All the public companies that are listed on stock exchanges have a definite number of outstanding shares available for trading.
• A stock split is a decision taken by the board of directors of a company to divide its existing shares into multiple shares. In simple words, The process of dividing the outstanding shares into further smaller shares is known as stock splits.
• In this the market value of the total outstanding shares of a company remains the same but market value of a single share is reduced in proportion to the no of shares extracted out of a single share.
• Thus, although the number of shares outstanding increases by a specific multiple, the total value of the shares remains the same compared to pre-split amounts, because the split does not add any real value.
• The most common forward split ratios are 2-for-1 or 3-for-1, which means that the stockholder will have two or three shares for every share held earlier.
• Reverse stock splits are the opposite transaction, where a company divides, instead of multiplies, the number of shares that stockholders own, raising the market price accordingly.
• People often confuse bonus shares with stock split. Distribution of bonus shares only changes its issued share capital whereas stock split splits the company’s authorized share capital

Example of Stock Split

Example 1

• To explain stock split further, consider the example of Stock split done by SBI in November 21, 2014.
• Share price of State Bank of India closed at Rs 2920.9 on November 20, 2014 and on the next day (November 21, 2014) it closed at Rs 297 after the stock split as it announced a stock split of 10:1.
• The only main reason that stock splits are done is to attract new investors and increase liquidity of the shares in the market. Value of the company does not change at all.

Example 2

• To explain this, consider one more simple example continuing the previous example. Assume that there are two investors Harish and Aman. Both wanted to make an investment of Rs 300,000 in SBI.
• Harish bought the shares on Wednesday which was the last day before the split date. Harish ended up buying around 103 shares at a price of Rs 2,900 per share, with Rs 1300 left from his available funds of Rs 300,000.
• Second investor Aman thought he was smarter and waited for the stock to split and bought it on Thursday. For the same amount of Rs 300,000, he could buy 1034 shares at Rs 290 per share and is left with only Rs 140 left with him out of the total fund of Rs 3 lacs. In this way, stock split gives enormous liquidity, especially for retail investors.
• But by the end of the week when Harish checked his Demat account, it would show that he holds 1030 shares of SBI rather than the 103 he bought, but his holding value will be the same as earlier. This is because of the fact that shares of all the shareholders would be split in the same ratio without impacting the value of holding, irrespective of the date of purchase.

Why Do Companies Split stocks?

• A stock split is usually done by companies that have seen their share price increase to levels that are either too high or are beyond the price levels of similar companies in their sector. That is the company finds that the liquidity of its stock in the market is very less due to high value of its stock.
• The primary motive for stock split is to make the stock more affordable for the small retail investors. It, thereby increases the investor base. This results in a renewal of investor interest of the company which has a positive effect on the share price in the short term.
•  A retail investor generally doesn’t not prefer trading in a highly valued stock and lowering the stock value helps increasing the stock liquidity.  This has the practical effect of increasing liquidity in the stock. However, the underlying value of the company does not change.
• Stock Split is done to enhance the liquidity in the market as the number of shares is increased. High liquidity results in an efficient market with the low bid-ask spread.

We have many companies trading at very high prices. Consider Eicher motors trading at Rs 20015, MRF trading at Rs 54628 or Bosch India at 16948 (as on 13.06.2019). So, let us also try to understand why many companies don’t go for stock-split even when their shares are trading at very prices. Main reasons behind this are:

1. Institutions play a major role nowadays and for them it doesn’t really matter if they are buying a share at Rs 250 or Rs 25000.
2. When a stock price is really low, it invites a lot of day-traders, increasing the volatility. When the share price is kept high, there is a slightly less volatility from high frequency trading.
3. It increases buying and selling cost, because of spread. (Spread means difference between buying quote and selling quote) because higher valued stock have lower spread. Today you will find in Bosch Buying quote of Rs. 25000 and selling quote of Rs. 25003 but you won’t find any company’s quote for buying Rs. 250 and Rs. 250.03 for selling because minimum tick size is 5 paise. 
4. Sometimes management thinks that stock split doesn’t make any difference to company’s performance or company’s valuation.
5.  It is bit of attitude issue too. If a company split its share by 10:1 than stock prices will come from say Rs 2500 to around Rs.250, but that makes it an ordinary company in the eyes of a lay man. Today Bosch / MRF get difference respect due to their share prices. Also, notice that in 90’s Cipla’s share prices were higher than Bosch but it gave huge bonus and stock split. Today, people don’t see Cipla something very different from Ranbaxy / Sun Pharma / Lupin / Wochard of the world. 

Impact of Stock Split

Stock splits are generally done in bull markets, as many shareholders will want to retain the wealth and even see an increase in the share price, mainly caused by increased liquidity and demand of the stock.

1. Share Price : When a stock splits, it can also result in a share price increase following a decrease immediately after the split. Since many small investors think the stock is now more affordable and buy the stock, they end up boosting demand and drive up prices. Another reason for the price increase is that a stock split provides a signal to the market that the company’s share price has been increasing and people assume this growth will continue in the future, and again, lift demand and prices.
2. Market Capitalisation : Fundamentally speaking, value of the company or market capitalisation of the company does not change after a stock split.
3. Earnings per Share : Financial ratios get adjusted according to the number of outstanding shares. So, if a stock had an earnings per share (EPS) of Rs 90 before announcing a 10:1 split, the new EPS for the company will be adjusted to Rs 9.
4. Dividend per Share : Dividend for every share (dps) will also reduce proportionately after stock split. But things in the vibrant stock market can be different.

Significance of Stock Split for Company & Investors

For Company :

1. In case of forward stock splits, the number of shares increases hence the ownership base of the company increases. The shares can now be owned by a wide range of investors.
2. Liquidity of the stock increases, thereby increasing the market efficiency of the stock.
3. There is no change in Authorised and Issued capital of the company as it remains the same.
4. In case of reverse share splits, the company can sideline penny stock traders as the price of the share increases.

For Investors :

1. In case of forward splits, shares are now more affordable to investors. Those who are already invested does not benefit apart from an increase in a number of shares, however since the price of share also decreases, the overall value for them remains same.
2. Future Earning per share (EPS) may reduce as numbers of shares are increasing. However, for existing investor, there may not be any impact as his existing numbers of shares are also increasing.
3. For a Share split of a blue-chip company, there is a positive perception about further growth of the stock price to pre-split levels during the growth phase of the company.
4. Share splits are tax neutral. There is no flow of money during share splits hence there are no tax implications due to this.
5. In case of reverse stock splits, investors need to judge the reason for the same and if the same is for avoiding delisting of stock from the exchange, it may be perceived as negative.

What Should the Investors Do?

• We advise investors to not just go and buy the stocks going for split. While a split makes the stock more affordable for investors, they should also look at the company’s fundamentals before putting in their hard earned money in the stock. They must carefully look at a proportionate growth in the bottom line (Profit After Tax) of the company before investing in such stocks. 
• “What really creates wealth for the shareholders is not bonuses and splits. A split or bonus with a consistent growth in the bottom line is what investors should look at before investing in such counters.

Benefits of Bonus Share Issue

Introduction

Bonus share Issue is a way of distributing the corporate’s earning to the shareholders, not given out in the form of dividends but converted into free shares.

What is Bonus Share?

• Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that a shareholder owns. These are company’s accumulated earnings which are not given out in the form of dividends, but are converted into free shares.
• The basic principle behind bonus shares is that the total number of shares increases with a constant ratio of number of shares held to the number of shares outstanding.
• For instance, if Investor A holds 100 shares of a company and a company declares 4:1 bonus, that is for every one share, he gets 4 shares for free. That is total 400 shares for free and his total holding will increase to 500 shares.
• Notice that Whenever a bonus issue is announced, the company also announces a record date for the issue. Record date is the date on which the bonus shares takes effect, and shareholders are entitled to the bonus shares on that date.

How bonus shares are issued?

• Bonus shares are generally issued by using the free reserves of the company. Every year, companies retain some part of their earnings and give the remaining part to shareholders in the form of dividends, as the most common way.
• Companies accumulate these retained earnings over time. So, with the bonus issue, these reserves will be converted into the capital. If we take a closer look at the balance sheet, we observe that capital is simply being transferred from the retained earning account to paid up capital account.
• Hence, the overall shareholder’s equity remains same. So, when bonus shares are issued, bonus prices will adjust according to the bonus ratio keeping the total market capitalization of the company same.
• So, if a bonus issue of 1:1 is announced, share price will half and no. of shares with the shareholders will double

Impacts of Bonus Share Issue

• In most of the cases, the stock price of a company rises after a bonus issue. While analyzing the effect of bonus issue on the share price of the company in two stages.
  • Share price movement from the time the issue is announced till the record date
  • Share price movement one year after the record date
• It can be seen that there is a positive trend in the share price movement of the company post bonus issue announcement till the record date and even one year after the bonus issue date.
• After the bonus issue, the share price of the company gets adjusted as per the bonus ratio i.e. the total market value of the company remains same. To understand this, consider one example. Suppose the stock price of a company before bonus is Rs 200 and a company issues bonus shares in the ratio of 1:1, the post-bonus share price will be Rs 100 and the total market value (2 x Rs 100=Rs 200) remains the same.
• Bonus share also increase liquidity. As in above example, after bonus share, stock price of the company will adjust as per the bonus ratio. So, stocks are available at a lower price now, thus increasing liquidity. It makes it easier to buy and sell.
• After bonus share, the value of Earning per share or EPS will go down.
• Earnings per share (EPS) = Net Profit / Number of shares
• As the profits remain the same and the number of shares increases, the value of Earnings Per Share (EPS) will go down.
• Since total numbers of shares are increased as a result of bonus issue, dividend per share may be less.

Benefits

A. From Company’s Perspective :

1. By issuing bonus shares, companies can satisfy shareholders when they don’t have enough cash to pay dividends. They can then use the cash in their expansion or other planned projects.
2. Issuing bonus shares means capitalisation of profits, which always increases the credit worthiness of the company. It also improves their credit rating which means they can borrow at a better rate.
3. A bonus issue indicates that the company is booming and it is in a position to service its larger equity.
4. Liquidity cash position of the company will remain unaltered with the issue of bonus shares because issue of bonus shares does not result into inflow or outflow of cash.

B. From Shareholders’ / Investors’ Perspective :

1. Shareholders need not pay tax on the bonus shares. However, in the case of dividends, they need to pay tax. It is beneficial for those investors who believe in the long-term growth story of the company.
2. If needed investors can sell some of the shares to meet their cash demands, thus increasing the flexibility for them.
3. Shareholders will get additional shares as a result of bonus issue. So, the investors will get additional dividend as a result of additional shares.
4. Issuance of bonus share leads to increase investor’s confidence in operations of the company. Post the bonus, the share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the shareholder. However, a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up.
5. So, when stock prices move up in the long run, there will be a dramatic increase in the wealth of shareholder.

Stocks Vs Bonds : What Is The Difference?

In this article, we are going to do a comparison Stocks Vs Bonds and differentiate between them on the most fundamental level. There are two ways in which a company can raise capital, by borrowing money which is debt or by selling shares of itself or via equity.

A security is simply something that can be bought and sold and have a claim on something to have an economic value. So, a security in the equity market is a stock and a security in the debt market is a bond. Stocks and bonds are also the two main classes of assets which investors all over the world use in their portfolios. However, there are many types of stocks and bonds with varying level of volatility, risk and return, which leaves you with the most difficult job of selecting right financial assets in your portfolio. So, to construct a good portfolio that grows well over time, it is a very important need to clearly understand the differences between stocks and bonds as asset classes for investments.

Stocks Vs Bonds Comparison

Let see the difference based on the above mentioned points :

1. Meaning

• Stocks are the equity instruments representing an ownership interest in a corporation and are traded on stock exchanges.
• Bonds are the debt instruments with a promise to pay back the principal amount with interest at a specific date and are traded on bond exchanges.

2. Who Are the Issuers?

• Stocks are issued by only companies who look to raise capital to use it for expansion projects and further grow the company or because the owner of the company wants a big lump sum of money for themselves as a reward for the hard work they have put in building the company.
• Bonds are issued by government institutions, financial institutions and companies etc. to borrow large sums of money for expansion, acquisition or other use.

3. Working of Shares & Bonds

• Here’s how shares work : Let’s consider a company who has made it through its start-up phase and has become quite successful. The owners of the company now wish to expand, but they are unable to do so on their own income that they earn through their operations. So, they can turn to the financial markets for additional financing. One way to do this is via stock market i.e. to split the company up into “shares,” and then sell these shares in the stock market through a process known as an “initial public offering,” or IPO. A person who buys Stock, is therefore buying an actual share of the company, which makes him or her a part owner – however small.
• And here’s how bonds work : When companies need money to fund their expansion, issuing bonds is the second way to do it. For better understanding, consider a bond like a simple loan. The investor agrees to give a specific amount of money to the issuer and the issuer pays regular interest (coupon payments) on it. At maturity, the total amount (loan principal) is paid back to the investor. Many companies chose bonds and not bank loans because the coupon payment is often less than what they need to pay on loans. Also, there are many limitations in case of bank loans but bonds give you a lot of flexibility to use the raised capital.

4. Returns

• Stocks pay dividends to the owners, but only if the corporation declares it. Profits earned by the company are paid in the form of Dividends to the shareholders of the comapny. When investors invest in stocks, they are more interested in the price growth potential of the stock/company ie. the capital appreciation in the stock price of the company.
• Generally, the bond contract requires that a fixed interest payment be made every six months or every twelve months. Interest payments are made in the form of Coupon Payments.

5. Risks

• Investing in stocks is much more riskier compared to bonds, as the returns are not guaranteed. Stock prices can fluctuate a lot over any time horizon and this volatility can decrease you share price to great levels. If you use leverage to invest in stocks, like buying on margin or short selling, you could even lose more than what you invest. So, for proper risk management, it is always recommended to hold a mix of stocks and bonds in the portfolio. Market risk, Business risk are the major risks associated with the stocks.
• Bonds are considered to be very low risk investment type, but not completely risk free. The most common risk is interest rate risk. If the interest rates in the country starts increasing, the bond prices will start falling. Since bonds are generally long term investment, inflation risk is also there as with the inflation, the value of money will decrease with time. Bonds also involve market risk, as with the economic conditions worsening, it may be difficult for companies to make coupon payments or even the principal payment at maturity, in the worst case.

6. Additional Benefit

Shareholders get the right to vote, while Bondholders get the preference in terms of Repayment and also on liquidation.

7. Traded Over

• Stock market has centralised place also called as stock exchanges, where stocks are bought and sold. Brokers do it on the behalf of buyers and sellers using a well-developed electronic system.
• Similar to the Stocks, Bonds are also traded over the exchages/platforms like NSE, BSE etc In the primary bond market, the entity that needs to borrow money invites the general public or investment banks to purchase their bonds. In the secondary market, the investors who had purchased the bond previously, sell their bonds to other investors. Various brokers operate in the secondary market who facilitate these transactions.