UNDERSTANDING STOCK MARKET

 

WHAT ARE SHARES?

A share stands as a unit of possession in a corporation or financial asset.

However, owning shares in a business doesn’t render a shareholder to have direct control over the business’s day-to-day operations nor makes him entitled to an equal distribution in the profits if they are in the form of dividends.

Each share signifies a proportionate stake in the equity of a company. You can select from buying large or small shares to match the amount of money you want to invest. A company's share price can accelerate or decrease as a result of its own performance or market conditions.

 

WHAT IS A STOCK MARKET INDEX?

When people speak about market going up and down, referring to a performance that is strong or weak or turning bull or bear, this indicates the market as it’s seen through lens of indexes.

The various indexes of the different segments of the market do not move in parallel hence multiple indexes develop.

A stock market index is a measurement of the value of a section of the stock market and is calculated from the prices of selected shares. It is a tool used by investors to describe the market and to compare the return on specific investments. For example, KSE-100 index is a measurement of the value of 100 selected stocks listed on the Karachi Stock Exchange.

 

HOW SHARES ARE MADE PUBLIC FOR THE FIRST TIME?

Shares are made public through an initial public offering using a book building process.

Initial Public Offering (IPO)

Initial public offering (IPO) is when a company issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to increase, but can also be done by large privately-owned companies looking to become publicly traded.

In an IPO, the issuer gets the assistance of an underwriting firm, which helps in determining what type of security is to be issued (common or preferred), the most suitable offering price and the proper time to bring it into the market.

IPOs are a risky investment as it is tough to predict what the share will do on the trading day as well as in near future because, there is no substantial historical data to analyze the company’s standing. In addition to that the companies up for an IPO undergo a transitory growth period which is subjected to uncertainty for future values.

Book Building Process

In order to raise money, a company plans on offering its stock to the public and this process is called Book building process. This process is used either by an IPO (Initial public offering) or FPO (follow-on public offers) for effective price discovery. It is a mechanism where, during the tenure for which the IPO is open, bids are collected and compiled from investors at various prices, which are higher or equal to the floor price (lowest price at which bids can be made). The offer price is decided after the bid closing date. As soon as the cost of the stock is determined, the issuing company can then decide upon the division of its stock to its bidders.

HOW TO OPEN AN ACCOUNT WITH THE BROKERAGE HOUSE

To trade in the stock market through registered brokerage house/broker, an investor has to open a trading account with the broker/brokerage house.

• Account opening forms generally can be obtained from the office of the registered brokerage house/broker or their branch office.

• Account opening form of the brokerage houses must include the basic clauses as mentioned in the Standardized Account Opening Form which is a part of the General Regulations of the Exchanges (these regulations are available on website of the exchanges).

• While filing up the Account Opening Form, an investor is advised to read carefully all the instructions printed therein, and if there is any uncertainty regarding any clause it is important to always consult the brokerage house/broker. If the query is not addressed satisfactorily; the investor can contact the Exchange's management and/or the SECP.

• While filling the Account Opening Form investors are advised to be vigilant.

• Investor should never sign any blanket authority allowing the brokerage house/broker and/or agent to transact on their behalf, unless and until he/she can clearly identify the benefits/specific purpose of such authority.

• A copy of certified and duly signed copy of Account Opening Form should be kept for record.

• Remember, that the Sub Account Opening Form does not include a general purpose authorization to the brokers to take care of their client’s securities. Nevertheless, specific authorization for managing the securities may be given out by the client.
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ROLES AND RESPONSIBILITIES OF BROKERAGE HOUSE

Brokerage houses/brokers are responsible to carry out the following duties:

• Brokerage houses/brokers must comply with the agreement signed between the investor and them 'in terms of the Account Opening Form'.
• Brokerage houses/brokers must comply with applicable rules and regulations. (Rules and Regulations are available at the website of the SECP www.secp.gov.pk and that of the respective stock exchanges).
• Brokerage houses/brokers must provide the investors with set of rules/regulations.
• Brokerage houses/brokers must comply with the code of conduct enshrined in laws.
• Brokerage houses/brokers must provide trade confirmations to the investors within 24 hours of trade execution.

Brokerage houses/brokers must not take deposits on fixed return.

 

 

RETURN ON INVESTMENT IN SHARES

(Dividends & Capital Gains)

As a shareholder, you own a part of company, which entitles you to a potential profit on your investment. Calculation of Return on Investment (ROI) is the basic part to be understood therefor the definition can be rewritten to suit the situation relying upon what you add as returns and costs.

Let’s take an example:

A marketer takes the comparison of two products by dividing the gross financial gain that each product has made by its respective marketing expenses. On the other hand, a financial analyst would compare the same two products in an entirely different ROI calculation which can go by dividing the net income of an investment by the total worth of all resources that have been applied in the making and selling of the product.

In a broader term, ROI is:

“The profitability measure that estimates the performance of a business by dividing the net profit by net worth”

Making a return on your investment is subjected to on how well the company does - evaluated by its stock performance - and if the company pays a dividend. Capital appreciation (the stock price rising in value), and dividends are the two ways you can earn a return as a shareholder.

• Capital Appreciation

Capital appreciation is:

“Certain rise in the value of an asset based on the rise in the market price”

Buy a stock, and when the price escalates, sell the stock for a profit, or hold onto it and hope that it rises even further over an extended period of time. The amount you make on the stock when you sell it is your "capital gain" for tax purposes. You can calculate your percentage ROI by taking the sale price and subtracting the purchase price out of it. You can now divide that total by the purchase price, and then multiply the amount you receive by 100. What you are getting now is the percentage return on investment. If the stock price drops, you can sell or hold onto the investment and that’s your choice. But you will face a capital loss and a negative ROI.

• Dividends

Dividend is:

“A portion of the company’s earnings distributed amongst its class of shareholders decided upon by the directors.”

Companies distribute a dividend in the form of a quarterly payment paid to shareholders for each share they own. This provides the investors a stream of income. In order to receive the dividend, you must have the shares of the company before the ex-dividend status, (The date at which the person has been confirmed by the company to receive the dividend payment). If you own 100 shares, and the company pays a Rs.10 dividend, you will receive Rs.1000 annually in dividend income.

 

RISKS ASSOCIATED WITH INVESTMENT IN SHARES

Shares can be a sound long-term investment but of course there are always risks to be considered as with any type of investment. These include the following:

1.   Volatility

Share values can be volatile and can fall dramatically in price, even to zero.

2.   Credit Risk

Owners of ordinary shares are generally the last in the line of creditors if a company fails and there may be no chance of getting any money back. 

3.   Unexpected Events

Unexpected events which are outside of your control, such as company specific bad news, a change in government policy or natural or man-made disaster can seriously affect share prices.

 

TYPES OF SHARES

Shares can be widely divided into two categories namely, ordinary shares and preference shares.

1.   Ordinary Shares

Ordinary shares carry no exceptional or preferred rights. Ordinary shareholders are entitled to share in the earnings of the company.  They can vote at the company’s general meeting as well as other official meetings. They are also eligible to participate in any dividends or any distribution of assets on winding up of the company.

2.   Preference Shares

Preference shareholders usually get a significance or 'priority' over ordinary shareholders in terms of payments of dividends or on winding up of the company. There are varying degrees of preference shares having different rights and characteristics. Holders of preference shares are entitled to having a fixed periodic income and have restricted voting rights liable to particular circumstances or particular resolutions; however this is strictly dependent on the terms of the shares. 

 

WHY DO COMPANIES ISSUE SHARES?

Companies issue shares to raise money from investors who tend to invest their money. This money is then used by companies for the development and growth of their businesses.

Company issues different types of shares namely; preference shares, ordinary shares, shares without voting rights or any other shares as are approved under the law. These allow the shareholders a stake in the company's equity as well as a share in its profits, in the form of dividends, and the aptitude to vote at general meetings of shareholders.

 

HOW TO TRADE IN THE STOCK MARKET?

The most common way of buying/selling shares in stock market is via trading through exchanges, where buyers and sellers meet and decide on a trading price. Through a stockbroker you can buy shares from existing investors who wish to sell them and vice versa.

There are also some exchanges which are physical location known as trading floors, where often trading is carried out. You might have come across in pictures where traders are yelling, waving up their arms wildly in air. The other means of exchange is virtual and is carried out via a network of computers where trading can be done electronically.

The aim of a stock market is to simplify the exchange of securities between buyers and sellers which can in turn reduce the risks associated with investing. So a stock market can be considered as a super-sophisticated market providing a linkage between buyers and sellers.

It’s important to have a sound knowledge between Primary and Secondary Market if someone wishes to trade.

Primary Market

Primary market is where the securities are made via an IPO.

Secondary Market

Secondary market is where investors trade the already-issued securities without involving the issuing companies. It is what people refer to when they are talking about the stock market.

An investor or stake holder have to trade through registered brokers/brokerage houses of the stock exchanges and it doesn’t require the direct involvement of the company. Each stock exchange has a number of brokers/brokerage houses which are registered with the commission. Registered Brokers/brokerage houses are allowed to engage in execution of trade on others' behalf as per the laws, rules and regulations. The following points are of key importance if you are opting for trade.

• To ensure protection against fraud and misrepresentation an investor should trade only through registered brokers/brokerage houses and agents.
• To verify authenticity of brokerage house/brokers/agents registration, SECP has uploaded a list of registered brokers and agents of the Stock Exchanges on its website (www.secp.gov.pk). It is important to note that the registration of all the brokerage houses/brokers and agents are valid for a period of one year which is subject to annual renewal.
• Make regular enquiries from your broker/
• If you come across any unregistered/illegal broker/agent, please report the same immediately to the SECP as it is in your own interest and in the general interest of other investors.
• The list of registered brokerage houses/brokers and agents can also be found on respective websites of the Exchanges.

 

HOW TO OPEN AN ACCOUNT WITH CDC?

• "Sub Accounts" at CDC (Central Depository Company) are maintained by the brokers on behalf of its clients (investors), therefore the clients (investors) cannot operate this account directly. However, information about securities lying in its sub account can be attained through broker/brokerage house or directly from CDC.

• Securities available in the sub account are the property of the account holder/investor.

• Another type of account at CDC is the "Investor Account" which allows investors to directly open and maintain accounts with CDC for safe custody and settlement of securities.

• These investor accounts can be opened simply by submitting a duly filled and signed "Investor Account" Opening Form available at the CDC offices or from CDC website available as a downloadable form.

• The account holder is the only person who can withdraw securities from the CDC Investor Account implying security and safe custody of the assets held in the account.

• Investors can keep track of their CDC account position by subscribing the Interactive Voice Response System with call center support through toll free number (0800-23275) or www.cdcaccess.com.pk. More information relating to operating of accounts at CDC and acquiring details, CDC office can be contacted at address and numbers mentioned at the end of the guide.

 

 

COSTS ASSOCIATED WITH BROKERAGE SERVICES

• Stock brokerage costs alter according to the extent of services you avail.
• You should pick out the service that meets your needs and requirements.
• Before you start getting involved in dealing with shares, specify how much you need to pay stockbrokers for the services they offer.
• Charges will vary depending on whether you wish to invest directly or indirectly.
• Enquire if there are any ongoing costs of stockbrokers, apart from the dealing commission each time you buy or sell.

 

KEY POINTS FOR INVESTING IN SHARES

All stock market investors are required to pay attention to the following to avoid any problem/fraud:

1. Verify authenticity of brokerage house and broker/agent.
2. Never sign any blank document or cheque.
3. Always make payment through cross cheque in the name of the brokerage house/broker.
4. Keep documentary evidence of the following:
1. Certified duly signed copy of Account Opening Form
2. Copy of document evidencing payment made to and received from the brokerage houses/brokers
3. Daily Trade Confirmations (in writing) received from the brokerage houses/brokers.
4. Periodical statement of their account and sub-account   statement (which   can   be obtained from CDC in case of maintenance of sub­account)
5. Any communication between the investor and the brokerage houses/brokers
    
5. Furthermore, investors must check for the following on trade confirmation slip:
1. Name and number of securities;
2. Date on which the order is executed;
3. Nature of transaction (spot, ready or forward and also whether bought or sold);
4. Price at which the transaction is executed; and commission charged by the brokerage house/broker.

 

BENEFITS OF INVESTMENT IN SHARES

There are many benefits to investing. Let’s find out how this common form of investment can be an effective way to make money. Here are some of the benefits of investing in shares.

1.   Capital Growth

Selling a share for more than you paid for it is known as Capital Gain. This occurs when an individual experiences significant rise in share prices and is one of the long term objectives of investing in shares.

2.   Dividends

Dividend is a cash reward given out to shareholders as part of the profit made by the company at the end of each financial year. The larger the units of the shareholdings one possesses, the more money one receives.

3.   Liquidity

By nature, shares that are listed are a very liquid product and can be bought and sold quickly over an exchange platform. No hassle of involving a broker or transferee and at a relatively low cost as compared to other financial products. Trading on an exchange also allows one to sell part of the share parcels other than redeeming the whole lot.

4.   Shareholder Benefits

Some listed shareholder companies from different market sectors including entertainment, retail, hospitality and financial services offer lavish discounts to shareholders when they buy goods or services from the companies or their affiliates. However, in most scenarios, lots of shares need to be owned to qualify for such benefits.