The share market has become a popular investment avenue for many due to the attraction of good returns. It is a marketplace where shares are bought and sold. The stock market is a significant factor in the economic development of a country.
It is volatile and reacts to various indicators of economic growth such as inflation, GDP, corporate earnings, and more.
Investors invest in the stocks of a company to benefit from the growth of a company. For their investments, they can earn dividends and capital returns.
But to understand the concept of the stock market, you need to, first, understand the concept of shares.
So, let’s explore –
What are Shares?
The capital of a company is divided into equal units of finite numbers of instruments known as a share. Each share represents per-unit ownership of the company. If you invest in a share, you are said to be investing in the company.
For example, say a company issues 1 lakh shares and you invest in 10,000 of them. In such a case, you would be said to own 10% of the company.
For your investment in a company’s shares, you are rewarded. If the company earns a profit, a part of such profit is distributed in the form of dividends to shareholders. Moreover, if the company grows, the value of its shares also grows.
This gives you capital appreciation on the invested amount.
Why do companies issue shares?
Issuance of shares is considered to be one of the easiest, advantageous and successful ways to raise funds for operation and growth. Besides the primary reason for raising funds from the market, there are many other reasons why companies issue shares. Some of the common reasons are as follows:
- To get funds to purchase assets and equipment
- To get funds for establishing and developing new projects or products
- For expansion
- To increase its inventory
- To pay off the debts or to redeem its debentures
- To increase its flexibility and liquidity
- For the purpose of merger and acquisition
- To get market visibility
Types of Shares
There are different types of stocks that are traded in the Indian stock market. These shares can be classified on the basis of various parameters. The parameters of the classification of the stock and the different types of shares under each classification are discussed below:
1. Types of shares on the basis of Stock classes
Stocks classified on the basis of classes are primarily of three kinds. They are as follows:
a). Equity shares
Equity shares are ordinary shares of the company which provide voting rights to the shareholders. These shares are also called common stock. Profits are distributed on equity shares in the form of dividends but the dividend is not guaranteed.
It depends on the profit earned by the company in a financial year. Moreover, in the case of liquidation of the company, equity shareholders are paid at the end.
The assets of the company are used to pay off the creditors and liabilities. Thereafter, preference is given to preference shareholders who are paid off for their investments. Once the preference shareholders are paid off, equity shareholders get the residual assets of the company.
Equity shares suffer considerable volatility and price fluctuations but also have the potential of giving attractive returns too.
b). Preference shares
Preference shares are the shares for which the shareholders receive preferential treatment.
The dividends are paid on such shares at a guaranteed rate before a dividend is declared on equity shares.
The preference share capital is paid before paying the equity share capital at the time of winding up of the company. Preference shares do not carry any voting rights and they cannot participate in the decision-making matters of the company.
However, if the dividend in respect of a class of preference shares has not been declared or paid by the company for a period of two years or more than two years, then such class of preference shareholders will be entitled to vote on the resolutions and shall have voting rights.
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2. Types of shares based on voting rights
Shares might or might not carry voting rights. As such, they can be differentiated on this parameter as well. Here are the types of shares based on voting rights.
a) Differential voting rights shares
Differential voting rights equity shares are the common equity shares that do not have voting rights. These shares are traded in the stock exchange like other regular equity shares but at a discounted value and carry higher dividends in comparison to ordinary equity shares. A company planning to offer differential voting rights equity shares is required to fulfill the eligibility criteria before issuing it.
b) Shares with voting rights
These are equity shares that have full voting rights. Shareholders owning these types of shares can vote on the managerial and executive matters of the company. They can vote at the company’s meetings and play a part in the management of the company.
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3. Types of shares on the basis of tradability
Stocks of companies might have different trading features. This, further, differentiates shares. Have a look –
a) Derivative stocks
Derivative stocks are stocks that are offered with an inbuilt derivative option.
These stocks are contracts that derive their value from underlying assets. Derivative stock comes with a ‘call’ or a ‘put’ option.
A call option offers the option of buying back the stock by the company at a certain price on a certain point in time whereas a put option provides the holder to sell the stock to the company at a certain time and a certain price.
b) Hybrid stocks
Hybrid stocks are nothing but preference shares that give you the option to convert them into equity shares after a specified time and if specific conditions are met.
So, when the shares are preference shares, you cannot trade them on the stock exchange.
But, if you opt for conversion and the shares are converted to equity shares, you get the option of trading them on the exchange for a profit.
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4. Types of shares on the basis of market capitalization
Market capitalization refers to companies’ total shareholding. The market capitalization of a company is calculated by multiplying the total number of shares outstanding in the market with the current market price of the stock of the company.
The market capitalization of the company is one of the significant factors to know the financial position of the company.
The Association of Mutual Funds in India prepares a list of companies based on their market capitalization. This list determines which companies are large-cap, which are mid-cap, and which are small-cap.
Then, depending on its classification, the company’s stocks are also classified in the same category. Have a look –
a) Small-cap stock
Small-cap companies are those that rank 251 and above in the market capitalization list issued by AMFI.
These stocks have the potential for good growth in the future and are a good choice for investors who are looking forward to investing their funds for the long term.
Investors who are willing to withstand price volatility and are not particular about current dividends can invest in small-cap stocks and make significant gains.
b) Mid Cap stocks
Midcap stocks are the stocks offered by companies listed between 101 and 250 on AMFI’s list. Such companies are those that are in their growth stages and have the potential to grow in the future.
Mid-cap stocks, thus, provide the benefit of attractive growth potential.
These companies have a good track record of consistent growth. When it comes to volatility, mid-cap stocks are less volatile than small-cap stocks.
c) Large-cap stocks
Large-cap stocks are the stocks of established enterprises which are also known as blue-chip companies with large capital reserves at their disposal. These companies are ranked from 1 to 100 on AMFI’s list.
Large-cap companies have already made a name for themselves in the stock market and they are market leaders.
As such, these companies have the capacity to withstand extreme market conditions without going bankrupt. Large-cap stocks, thus, are stable compared to mid-cap and small-cap stocks.
They offer high dividend income and give moderate returns on your investments.
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5. Types of socks on the basis of risk
Fluctuation in the share price is a determining factor of risk associated with stocks.
The higher the risk, the higher will be return and vice versa.
There are two types of stocks based on risk factors which are discussed as follows:
a) Blue-chip stocks
Companies with stable earnings and fewer liabilities issue blue-chip stocks to their investors. These companies are none other than large-cap companies which are also called blue-chip companies.
Blue-chip stocks offer regular dividend payments to investors and are issued by well-recognized companies having a history of stable financial performance.
These stocks are, thus, comparatively safer investment avenues for the investors who are looking for low risk and good returns.
b) High Beta stocks
High Beta stocks are the stocks that carry higher risk in comparison to blue-chip stocks. The risk is measured through the volatility of the stock price. It is also called beta.
The beta or the risk factor in the stocks can be positive or negative denoting its movement in sync with the volatility of the market or against it.
Higher the beta, the higher will be the risk of the stock, and the higher the returns.
Beta stocks with a beta value of more than one mean that the stock volatility is more than market volatility.
So, if the market delivers a return of 10%, stocks with a beta of more than 1 would deliver a return of more than 10%.
On the other hand, if the market falls by 10%, such stocks would fall by more than 10%.
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6. Types of shares on the basis of price trends
Stocks can also be classified on the basis of the movement of their prices in the market against the earnings of the company.
These stocks are influenced by the earnings of the company. There are two types of stocks based on price trends:
a) Cyclical stocks
Cyclical stocks are the stocks that encounter high fluctuations in their prices with changes in the market and are generally affected, to a great extent, by the economic conditions in the market.
These stocks grow very fast during the boom cycle. These stocks may slow down in changing economy. Stocks offered by automobile companies and airline industries fall under this category.
b) Defensive stocks
Defensive stocks are the stocks which not affected by the economic conditions and as the name suggests, it is used as a defense particularly when the market conditions are slow and poor.
Common examples of defensive stocks are stocks of food and beverages companies.
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7. Types of stocks on the basis of fundamentals
Some investors compare the prices of the shares with various factors such as profit earnings per share to find the intrinsic value of the shares.
These investors believe that the price of the share should be equal to the intrinsic value of the share of the company and based on this intrinsic value share the investors make investment decisions.
Types of shares on the basis of fundamentals are discussed as follows:
a) Undervalued shares
Shares whose price is less than their intrinsic value are referred to as undervalued shares. These shares are quite popular amongst value investors.
It is believed that the prices of the share will increase in the future and the investors may gain when the share price equals or increases its intrinsic value.
b) Overvalued shares
Shares with prices exceeding the intrinsic value are considered overvalued.
These shares are those which are considered valuable among investors. As such, the trading volume is high for such shares.
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8. Types of share on the basis of payment of dividend
The dividend is one of the most significant factors in the share market. They are mainly two types of shares on the basis of payment of dividends. They are as follows:
a) Income stocks
Income stocks pay a higher dividend in comparison to growth stocks. Income stocks show that the company is making a good profit and is stable enough to afford the payment of consistent dividends.
These stocks are named income stocks as the stock pays higher dividends to investors translating it to higher income. These stocks include preferred stocks.
To find the stocks offering higher dividends, investors can use the share dividend yield measure to calculate earnings per share from the investment.
b) Growth stocks
Growth stocks, as the name suggests, are the stocks issued by the companies which re-invest the earnings of the investors enabling the funds to grow faster.
These stocks do not yield higher dividends but offer long-term capital appreciation. The share value increases with the growth rate providing higher returns to the investors.
Growth stocks are a good choice for investors who are looking to invest their funds for the long term and not as a source of income. Risks involved in growth stocks are generally higher.
So, when investing in stocks, assess the type of stock that you are picking. Moreover, here are some stock investing facts that you should know about.
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Facts to know about shares and the share market
- Shares are risky investment avenues that, though have high profit potential, can cause considerable losses too. So, you should have a healthy risk appetite to absorb possible losses. Try and invest with a long-term horizon so that you can reduce the risks of stock trading.
- Have a diversified portfolio of stocks so that you can spread the volatility risks across different sectors of the economy.
- Shares are traded on different types of stock exchanges. The National Stock Exchange and the Bombay Stock Exchange are the two major stock exchanges in India.
- Stocks can be brought through a depository participant by opening a Demat account. Depository participants are intermediaries between an investor and the depository authority.
- There are two types of dividend, interim and final dividend depending on the classification of stocks.
- Shares are freely transferable by the shareholders and can be sold to another party.
- There are two types of shareholders i.e primary shareholders who purchase the stock when the company issues it and secondary shareholders who purchase the stock from the stock exchange in the secondary market.
- Shares are held in electronic mode in a dematerialized form through a depository and a depository participant.
- Companies can issues shares at their face value or at an amount higher than their face value. The difference between the amount of share price and its face value is called share premium.
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Tax treatment of stock trading
Buying and selling of shares, whichever type that you choose to trade in, attracts tax if you make a profit.
Here’s how the tax treatment works –
- If you sell the stock within 12 months of buying it, the profit earned would be called a short-term capital gain. Such a gain would be taxed at 15%.
- If you sell the stock after 12 months of buying it, the profit earned would be called a long-term capital gain. Such a gain would be tax-free up to Rs.1 lakh. However, if the gain exceeds Rs.1 lakh, the excess gain would be taxed at 10%.
- Dividends earned from stocks are taxed at your income tax slab rates.
The bottom line
The stock market is a technical platform where thousands of shares are bought and sold every day. Understand how the market works before you start your stock trading journey.
Also, when picking stocks for your portfolio, do a detailed analysis of the stock to ensure that it is profitable and would give a good bang for your buck.
Also, understand the different types of stocks available in the market and choose those which align with your investment needs and preferences.
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