But there is one thing; if you hold for long enough, i.e., for the long-term. Studies and numbers show that equity has been able to deliver higher than inflation-adjusted returns among all asset classes in the long run.
Here is a look at how to make money from the stock market.
Earning from capital appreciation
By investing in shares, one can expect to earn through capital appreciation, i.e., on the gains made on the capital (principal invested) when the share price rises. The gains or the profits from shares can go as high as 100 percent or more. There is, however, no guarantee of capital appreciation. The probability of the market prices remaining lower than the buy price always exists.
Earning from dividends
A company distributes profits to its shareholders by declaring partial or full dividends. In most cases, the company partially distributes profits and keeps the rest for other purposes, such as expansion. The dividends are distributed per share. If a company decides to give Rs 10 per share, and if the face value of the share is Rs 10, it is called 100 per cent dividend.Formula for computing dividend yield
Dividend Yield = Cash Dividend per share / Market Price per share * 100.
Here is how you can use the formula:
Say if the market price of a stock is Rs 120 and the dividend declared is Rs 4 per share, the dividend yield is 3.33 percent.
By investing in shares, the risk of losing a major part of one’s capital exists, unless one employs a hedging mechanism.
Here are a few things to know to earn money from stocks.
Types of stock markets
The stock market is divided into two main categories: primary and secondary market. In the primary market, securities are issued and subsequently listed on stock exchanges. Trading in these securities happens in the secondary market.
A public issue introduced in the primary market can be of two types: an initial public offering (IPO), or a follow-on public offering (FPO). An IPO is used when an unlisted company wants to raise equity capital by issuing shares. It results in the company’s shares getting listed on a stock exchange. In an FPO, a listed company issues shares to the public. It can be either a fresh issue or an offer for sale.
Factors impacting stock price
To earn money from direct equity, one needs to know the factors impacting the share price. A company’s share price does not move independently. Several internal and external factors are responsible for it. When a company is expected to grow faster, more people want to hold the stock. This leads to higher demand for the stock in the market, which results in higher prices. Further, acquisition plans, buyback offer, announcement of bonus, and splitting of share impact prices in the short term.
In addition, there are macroeconomic factors such as GDP, inflation, interest rates impacting performance and thereby stock prices. If the economy is doing well, the demand for goods and services will be higher, resulting in more profits for companies. Further, high inflation means higher prices and consumers will be able to buy fewer goods and services, hurting company’s sales and profits.
Stock selection requires knowledge of a vast range of subjects such as economics, finance, and corporate law. However, if you lack rigorous training in these subjects you can use some basic principles. Firstly, you should understand the company’s business; read the company’s financial statements like income statement, balance sheet, and cash flows. Don’t just focus on earnings. Balance sheet and cash flows are even more important.
After you have analysed the company’s financial health, look at its valuation. Strong balance sheet numbers coupled with lower valuations compared to peers or the index makes a strong case to buy. You can use various sources to gather information on stocks. The first one is the website of the exchange where the stock is listed. Here, you can find financial results and company announcements. Companies also publish their financials on their websites.
Building a diversified portfolio
Start by putting your money in different stocks, which is also called diversification. This diversification should happen across sectors and also across stock market capitalisations. Concentrating on one sector or putting all your funds in one market cap may not be the right thing to do.
Diversifying across sectors or industries helps if the economic environment is not favourable for any one sector as each sector has its own typical set of factors that impact the performance of companies. These include the economic environment, cyclical nature of business and the government policies. By diversifying, one is actually creating a stock portfolio, the overall return of which matters and not return from any 1-2 stock out of it.
Don’t try to time the market
Knowing the bottom or the peak in a stock’s history always comes to be known in hindsight. Rather than trying to time the market, focus on the time spent in the market. Waiting for the stock price to lower further down may not even come and many investors are left out in the waiting game. It’s better to stagger one’s investment at different price levels.
Avoid herd mentality
When the stock price shoots up, many investors feel left out. At times, without understanding the business and the company financials, new investors jump on as herd mentality takes over. Such a move can be financially damaging as it may amount to pure speculation and most investors could be at the mercy of big operators.
Further, when stock prices decline hugely in a span of few days, there could be unanswered questions and fear factors leading to its fall. The price reversal can be equally swift. Avoid the temptation to take decisions based on rumours or speculative reports.
When to sell
At times, stock markets could remain flat for a long period, while at other times it can be extremely volatile. Your decision to exit should ideally not be based on short-term market movements rather on your stock selection. If there are no fundamental changes in your stocks, including its financials and businesses, stick to it. Risk is inherent while investing in stocks and hence, one should be able to stomach the risk of seeing the share price slide down considerably. Keep some portion of cash in hand to make use of market opportunities. If your stock has performed well, booking profits may not be bad idea.