Month: October 2022

Introduction

Trading in the stock market is one of the ways to earn significant quick returns. 

Many people think that the stock market is a way to make easy returns, but gaining in the stock market requires knowledge about the stock market and how it works. 

Trading volume is one such factor that a trader should know of. A trader can use volume analysis to earn intraday returns out of the stock market. 

But, how can Volume in the stock market facilitate trading returns?

Let us understand the meaning of volume in the stock market and how to use the same in making trading decisions.

What is Volume in the stock market? 

We can understand volume in a general sense as a total number. In the stock market, the trading volume is the total number of shares traded in the stock market (bought and sold) during the trading period, that is, during a fixed period. The volume shows the measure of turnover of the shares.

Each ticket (each transaction) represents a trade and is calculated depending on the total trade price and counted towards the total trading volume. Although the same shares may be traded back and forth multiple times, the volume is calculated for each such transaction. 

So, if 500 ABC shares were bought, sold, repurchased, and resold, resulting in four transactions, then the volume would be registered as 2000 shares, though those 500 shares may have been played multiple times.

Therefore, volume is the total number of active shares. It can be a purchase order or a sales order. High volume indicates that the stocks are actively traded. Similarly, low volume indicates that the stock is not actively traded.

Trading volume can be measured for any type of financial instrument which is traded: stocks, bonds, derivatives (futures and options contracts), and gold.

Stock markets publish trading volumes on the stock market for each trading session. Volumes are reported for each stock and the total volume of stocks traded during the session in the exchange. 

Volumes can also be reported in indices. This helps us to know the volume of shares traded in Nifty 50 or Sensex for a particular trading session at any other time.

Where to find trading volume? 

All stock markets keep track of the volume of stocks. Stock market volume information is therefore easily accessible. One can look at trade, news websites, and third-party websites that have stock market information. 

Platforms also use candlestick charts to show volume over time. The green bar indicates the purchase volumes, and the red bars indicate the sales volume.

There are also volume charts depending on when someone wants to keep them in mind. There can be hourly, daily, monthly volume charts,100-day, 200-day volume charts, etc.

Generally, the trading volume of a particular stock on the National Stock Exchange (BSE) and the Bombay Stock Exchange (BSE) will vary. This is also one of the reasons why there may be a slight price difference between Sensex and Nifty 50 in the same stock. The stock should be listed on both exchanges for this to happen.

What is stock volume?

The stock volume reflects the action taken in the stock. The volume metrics record each activity, either selling or buying. 

If the stock shows more volumes, it means that there is a lot of trading activity happening for the stock. This can be negative or positive. There may be negative news developments that could encourage more sales. The opposite is also true.

Higher volumes indicate the more number of times a stock has changed hands. Volume is calculated as the total number of shares that are actually traded (bought and sold) during a trading day or a specified period of time. It is a measure of total stock turnover. Each ticket represents a trade and counts towards the total trade volume. While the same stock may be traded back and forth multiple times, the volume is counted on each transaction. So if 500 shares of XYZ were bought, then sold, then bought again, and then sold again, resulting in four tickets, then the volume would register as 2,000 shares, even though the same 500 shares may have been in play multiple times.

During one trading session, volumes are usually higher during market opening and closing as intraday traders rush to book and close their day portfolio positions. Trading volume analysis is profitable with short-term intraday traders.

Investors using fundamental analysis can also use trading volume as a tool to analyse any significant changes in the share during a longer period.

How does volume work?

The volume records the number of trades performed over some time. Liquidity in the market can be directly measured using volume. Major stock exchanges report daily volume statistics, both for individual securities and the total amount of trades made in the trading session. The volume also reflects price pressure. 

When market activity – that is, volume – is low, investors expect prices that are slow (or declining). When market activity goes up, prices often go the same way. In addition, technical analysts use stock volumes to determine the best trading and entry points.

How to find Volume on a Chart?

The magnitude of the trading prices is clearly shown throughout the trading day, usually below the price chart. Volume is usually displayed as a straight bar representing the total volume for an extended chart. 

For example, a 10-minute price chart could show volume bars that show the total trading volume for every 10 minutes. Volume bars are usually green or red. Green indicates the volume of net buying, while red indicates the volume of net selling. Some traders prefer to measure the volume with a moving average of the market to see if the volume is too heavy or thin.

Volume: Why is it important?

There are several ways that trading volume can help evaluate a stock and broader market trends as a whole.

For example, tracking volume can help you get an idea of ​​where the market is going collectively. If the volume increases overall, you can dig deeper and analyse what is causing the higher trading activity. Specifically, you would want to look at how prices move in relation to trading volume. When prices rise or fall sharply on increasing or decreasing volume, it can signal that the market is moving or about to move.

This, in turn, can help decide when to buy or sell. For example, in a market environment where prices are falling and volume is increasing, you may decide to buy at low and may earn a profit when the market recovers and prices begin to rise again. Or you may decide to sell some of your shares to minimise losses.

Trading volume can also send signals about whether the market is in a bullish or bearish trend or whether a particular stock is likely to have a breakout move. Breakouts occur when a stock’s price moves above a certain level. If the higher price holds, a breakout may follow. Trading volume can also help you identify potential false breakouts when the stock is signalling that the stock price is about to rise, but it actually isn’t.

What are Relative Volume and its importance?

The relative volume compares the current volume with the “normal” volume and displays it as a multiple. Normal volume is the average volume of the past predetermined days. 

If the relative volume is 4, it indicates that the stock is trading 4 times the normal volume. This represents an increase in trading activity that could lead to significant price fluctuations. 

Related volume is available on most trading/chart platforms. An increase in volume may indicate cash inflows or outflows, indicating action.

Using Volume to spot Momentum

Momentum shows the speed at which stock prices are moving; it changes over time and helps identify a trend. Rising prices indicate upward momentum, and falling prices indicate bearish momentum. Analysis of price vs volume can also help in determining momentum.

If the price is rising on low volumes, it shows a bullish trend with lasting momentum and indicates a likely trend reversal. Moving Average Convergence Divergence (MACD) is a useful momentum indicator. It helps traders to identify when a bullish or audible indicator is high to help them plan their exit or entry accordingly.

What are common volume indicators?

There are three commonly used volume indicators as below: 

On Balance Volume (OBV)

OBV is a simple indicator that uses changes in volumes in order to help predict stock prices. According to OBV, there is a correlation between volume and price. The overall direction of the on-balance volume line helps traders understand momentum. For example, if the OBV line rises, that suggests a bullish trend.

Chalkin money flow

Marc Chaikin, a famous American trader, invented the Chaikin Money Flow (CMF). The CMF is useful in measuring whether buying or selling pressure is dominating the market. According to Chaikin, if a stock’s closing price is near its high, it indicates accumulation or buying pressure. If the closing price is closer to its low price, it indicates selling pressure

Klinger Oscillator

The Klinger volume oscillator compares volumes with price, converts the result of the comparison to an oscillator and helps predict price reversals. The oscillator identifies long-term cash flow trends for specific securities. The Klinger Oscillator is more complex than the OBV indicator.

What is the relationship between volume and price?

If a stock with high trading volume is rising, it indicates buying pressure as investor demand pushes the stock to higher and higher prices. On the other hand, if the price of a stock with high trading volume is falling, it means that more investors are selling their shares.

However, high volumes are not the only reason why stock prices go up. Many factors affect stock prices. Although, in most cases, confirmation of a particular trend may be indicated using the volume analysis.

When viewed along with the market risk or the price risk, it can be a useful indicator. If the volumes are high and consistent, it may indicate that the stock markets are moving more smoothly and healthier. 

Therefore, sometimes, volumes can be a measure of market strength when analysed with other indicators as well.

 Let us better understand this with these statements:

• If prices fall and stock volume rises, it can mean the trend is showing downside movement.
• If the volume is going up with the market, it can mean the trend shows upside movement.

High vs Low Volume Stocks

When considering the volume and evaluating a particular stock, investors may want to consider how difficult it might be to get rid of their shares if they decide to sell.

Stocks with low volumes may be difficult to sell because there may be little buying interest. In addition, low-volume stocks can be quite volatile as the spread between the bid and ask price tends to be wider.

Stocks with high volume and rising prices are generally easier to sell at a desirable price.

When a stock has unusually high volume, it means something is going on with the company that investors should probably know about. It could mean that good or bad news has been released recently, but not necessarily. It is not always clear why stocks rise or fall sharply.

How to use Volume in trading?

Volume can be an indicator of market strength. Here are a few ways stock volume can be read and used.

It may indicate that the stock is a strong one to add to the portfolio

When a stock goes up, it means strength. Investors can assess how convicted traders are of a particular stock or the market in general. High volumes indicate a strong belief in the direction a stock or market is moving. However, volumes do not reveal the reason for a market trend, so investors will need to investigate why the trend is occurring.

Investors can use volume information to help them decide if a stock would be a good fit for their portfolio. For example, a rising stock should produce rising volumes, indicating a strong bullish conviction. However, if investors are seeing the rising price and falling volume, this indicates disinterest, meaning a reversal may be just around the corner. In such a scenario, it may not be a good idea to buy that particular stock. Investors who are bullish on the stock over the long term may want to wait for a pullback before buying if the stock’s recent price gains have been low.

It can indicate if the market is exhausted with a stock

Volume can also be used to determine when the market has sold out towards a particular action. When there is a sharp change in price and a sharp increase in volume, it indicates that the trend could end. Investors afraid of missing out tend to buy high, resulting in a surge in volume. However, when everyone has bought the stock, the price stagnates and then falls because the market has exhausted all the buyers interested in the stock.

On the other hand, when the stock bottomed out, many investors were pushed out by the falling price, causing high volumes and increased volatility. The volume then declines after the peak, although it may change again in the long term.

What’s a Good Average Volume for a Stock?

Some may wonder if higher trading volumes are good for stocks. There is no clear definition of what is a good volume for a stock. In fact, sometimes volumes can increase for reasons such as stock splits, news or other reasons.

Instead, it makes more sense to look at volume as part of the big picture when evaluating a particular stock. Traders typically use volume in combination with other factors, such as whether the price is falling or rising and how much volatility is present.

Bottom line

A stock’s trading volume reveals to investors how many shares are being traded. Investors combine this data with other information when examining whether a stock’s price is likely to rise or fall. Volume does not always indicate whether reversals are imminent, but it does offer traders some insight into what is expected to happen.

As mentioned above, investors will have an easier time selling stocks when the price is rising with high volumes. When shares are not traded frequently and there is limited buying interest, an investor may have difficulty unloading their shares. High volumes can indicate bullish or bearish sentiment and the level of investor conviction about a particular stock.

Introduction

As a corporation is an artificial person, it cannot produce its capital and must instead acquire it from other individuals. 

The individuals from whom money is raised are known as shareholders, and the amount they give to the company is known as share capital.

The phrase share capital might signify somewhat different things depending on the context. Accountants use a different definition, which applies to public company balance sheets. It refers to the entire sum generated via the selling of shares. There is also more than one kind of share capital, and each has varying properties, distinct from one another.

Let us explore the details of share capitals and the types of share capital that exist. Keep reading to have an easy and clear understanding of share capital.

What is Share Capital

Let us begin by answering the fundamental concept of this topic, “what is share capital?”

Share capital refers to the funds the corporation generates by issuing stock to the public, and it is also the amount of funds invested in a company by its shareholders. 

It is a source of long-term funding in which investors get a piece of the company’s ownership. Capital represents the amount of money required to begin a business, and generally, it refers to the funds contributed per the company’s memorandum of association. 

The assets used to operate a company are referred to as capital. There are several share capital kinds accessible on the market. And the entire nominal value of an organisation’s shares is known as its share capital. In the corporate governance framework, “capital” and “share capital” have been considered synonymous.

Due to the excessive number of shareholders, it isn’t easy to register separate capital accounts for each holder. Therefore, the various capital contributions from shareholders are accounted for under a single capital account referred to as the Share Capital Account.

Regarding a company’s financial statements, equity in the shareholders’ section represents the company’s share capital. Each funding source may need a separate line item for this information, and a third line frequently separates common stock and preferred shares for extra paid-in capital.

At the moment of sale, both common and preferred stock shares are valued at their par value. The “par” or total price is a fictitious figure in contemporary commerce. “Additional paid-in capital” refers to a corporation receiving more than the par value.

Only payments made directly to the business are included in the stated amount of a company’s share capital. The company’s share capital is unaffected by the subsequent financial activities of those securities and the increase or decrease in their values on the open market.

After its first public offering (IPO), a business may decide to make other public offerings. The company’s financial sheet would be bolstered due to the selling of further shares in the near future.

Now that you know what share capital is, it is essential to know about the various types of share capital which exist.

Types Of Share Capital

The phrase “share capital” may indicate various things based on the circumstances in which it is used. 

A business can raise a certain amount of money via selling shares in various ways, thus leading to multiple types of share capital. 

The types of share capital, alongside a fundamental understanding of them, are provided below:

• Authorised Share Capital

Authorised share capital is the entire amount of money a company takes from its investors in its lifetime by issuing shares mentioned in the company’s official documentation. 

The term “Registered Capital” or “Nominal Capital” refers to a company registered with this capital. Fundamentally, an authorised share is the sum of the issued and unissued shares.

According to Section 2(8) of the Companies Act, 2013, the maximum amount of Authorised Capital is determined by the Capital Clause in the Memorandum of Association. Even if the firm has the right to extend the limit via the relevant procedures, no shares may be issued by the business that exceeds the approved capital limit. 

• Issued Share Capital

Issued Share Capital refers to the part of Authorised Share Capital made available to the general public for subscriptions. 

The act of issuing shares is referred to as an “issuance,” “allocation,” or “allotment.” Authorised Share Capital is a subset of Issued Share Capital, in other words. After the shares are allotted, a subscriber becomes a shareholder.

• Unissued Share Capital

Unissued share capital refers to the number of shares a company has that can be used to obtain capital.”

Shares, as previously indicated, are typical in companies, and a difference between approved and issued capital will emerge as a consequence. The company’s unissued stock capital will be between the two figures. 

• Subscribed Share Capital

Subscribed capital is the amount of issued capital that has been subscribed by the general public. 

The general public need not take up a majority of the issued capital as the company will receive an application for this percentage of the corporation’s issued capital. 

For Instance: With an initial public offering (IPO) of 100 shares of Rs.1000, the company’s issued capital is Rs.100,000, and the public applied for 80 shares. The total amount of subscribed share capital is Rs.80,000.

• Called-Up Share Capital

Called-up capital is the allocated portion of the subscribed capital that is paid by the shareholders via their investment and may be used for company expenditures. 

This portion of the company’s capital is not supplied to it all at once. The remaining subscribed share capital is referred to as “Uncalled Capital.”

• Paid-Up Share capital

The amount of Called-Up Capital that shareholders have paid is referred to as Paid-up Capital. 

Shareholders do not have to pay the total paid-up capital all at once. The corporation may get half of the capital, referred to as the Reserved Capital, the capital that the shareholder has called up.

• Uncalled Share Capital

If a corporation offers stock to shareholders, it expects them to purchase it. However, they have the option of not doing so. 

If shares have been issued but not claimed, the term “uncalled share capital” is then applied. 

The shareholders’ contingent liabilities are included in this capital as well. To get this figure, you must subtract your called-up capital from the number of shares allocated.

• Reserve Share Capital

The reserve capital is the number of shares that cannot be sold without the company going under in reference to a corporation’s bankruptcy.

Following a vote of more than three-quarters, these shares are often issued. In the same way, corporations are unable to alter their memorandum of association to reverse their decision. The objective of reserve share capital is to facilitate liquidation.

Numerous limitations apply to reserve capital. Because of this, companies cannot utilise this money as a kind of security or a source of regular capital. On the other hand, companies can have it reversed by a particular court order. This capital cannot be accessed without the complete liquidation of the corporation.

• Circulating and Fixed Share Capital

The subscribed capital of a corporation comprises the circulating share capital. 

This capital is provided by operational assets such as bank reserves, book debts, and accounts receivable. These are the liabilities used for a company’s core activities. Fixed capital, which comprises a business’s fixed assets, is also closely tied.

The above mentioned were the types of share capital available. Now that you clearly understand the kinds of share capital, you should also know about the importance and use of share capital.

Importance And Use Of Share Capital

Share capital, also known as equity share capital, is an essential part of any company, and it brings numerous advantages to the company and the shareholder. 

To comprehend equity share capital, people must get acquainted with the definition of equity shares.

Preferred or equity shares that indicate a company’s ownership position. A corporation’s share sales may serve as an investment source for the company. Additionally, equity shareholders are stated to possess fractional ownership of a corporation.

It also offers stockholders the following benefits:

• Equitable liquidity

Share prices are proportionate to market movements or the company’s revenue creation and may be impacted on both accounts.

• Profits

In addition to the capital appreciation characteristic of equity shares, investors also may get dividends on their investments.

• Control over management

Shareholders possessing a substantial percentage of a company’s stock may influence its management considerably.

Why Do Corporations And Businesses Issue Equity Share Capital And What Is Its Purpose?

Typically, a corporation invites the common people to purchase its shares to obtain fractional ownership of the same. Such ownership allows stockholders to receive dividends as rewards. A significant privately held corporation would typically offer shares for public trading on a stock market. 

However, capital formation is the primary reason why small and big enterprises first offer shares to the general public. 

The equity share capital obtained via the issuance of equity shares is utilised to develop the company’s commercial endeavour. 

Additionally, a high capital basis helps them improve their market creditworthiness. When a corporation distributes shares to investors, they also provide the chance to earn a portion of its earnings and participate in its stock.

Share capital contributes highly to a company’s financial aspects, and thus you must also be aware of its contribution to the balance sheet. You must understand the role of share capital in the balance sheet.

Share Capital In Balance Sheet

In accounting, share capital has a much more technical definition. According to its representation on the balance sheet, the share capital is the par value of all equity assets offered to shareholders, including ordinary and preferred equity capital shares.

Non-accountant individuals often incorporate the stock’s price over par value in the calculation of share capital. As stated, the nominal par value of shares is usually relatively minor. 

Therefore, the gap between the par value and the actual selling price, known as paid-in capital, is often substantial. However, it is not officially considered part of the share capital or subject to approved capital restrictions.

For instance, here is what Share Capital in balance sheet would look like:

Consider that corporation XYZ issues 1,000 shares. Each share is priced at Rs.25 and has a par value of Rs.1. The corporation’s accountant will record Rs.1,000 as share capital and Rs.24,000 as extra paid-in capital, also referred to as the contributed surplus.

Share capital is generally represented in the shareholder’s fund section of a company’s balance sheet. 

Paid-up capital is considered the actual capital since it reflects the shareholder contributions. It is also added to the liabilities section of the balance sheet to complete the column.

That is the explicit representation of share capital in the balance sheet and plays a crucial role in the accounting field of a corporation’s finances.

Conclusion

Considering the various forms of share capital, it may be said that share capital is the par value of a company’s equity securities. It contains both preferred and regular equities that stockholders have sold.

Many forms of capital may be distinguished depending on the restriction on the issued and compositional shares. Each of these sorts is essential to a company’s financial health and is unique from the others.

With that, we can conclude that all the essential knowledge about share capital, also known as equity share capital, has been thoroughly detailed for your clear understanding. 

A finance enthusiast should have a thorough understanding of corporate finance, especially share capital. We hope the types and uses of share capital mentioned above helped you to gain a clear concept of this subject. 

Introduction

A recent survey suggests that one out of every five women are…….

Now you must have read such an analysis before, but tell me do you think they asked every woman out there to form that survey.

No. Right? That would be indeed preposterous. 

So, to conduct research and surveys, analysts use a viral method called Sampling.

Sampling is also trendy in the stock market. 

Yes!!!

A stock market index is nothing but a sample of the stock market. A group of premium companies is formed concerning a particular parameter, and this group is termed the stock market index. 

This group represents the whole market, just like how a group of women is representative of the global female population.

What is the Stock Market Index?

A stock market index is a statistical metric that shows the changes occurring in the stock market. 

To construct an index with a proper understanding, similar categories of equities are picked from among the securities already listed on the exchange and grouped and sorted as per various factors like industry preferences, market capitalisation, segment, etc.

 

The value of the index is directly proportional to changes in the underlying stock values. The index will rise if the prices of most of the underlying securities rise, and contrarily. 

However, a simple stock market index definition can be as follows:

Stock Market Index Meaning

A stock index is a measure of the stock market that allows investors to compare current stock prices to previous values in order to determine market performance. 

In a nutshell, stock market indexes are a collection of shares based on specific characteristics such as trading frequency and market size.

What is the purpose of the Stock Market Index?

We know that a stock market index, usually referred to as a stock index, is a statistical metric that measures market fluctuations. Hence, a stock market index functions as a barometer, indicating the market’s overall state. The indices make it easier for investors to recognise a holistic pattern in the market. When the investors want to select the stocks they want to invest in, they use the stock market index as a guide.

The value of the index is affected by changes in the prices of the underlying securities. If prices rise, the index will increase, and if prices fall, the index will fall.

Listed below are a few points that aim to elaborate on the importance of the stock market index stating why it is so necessary for the investors.

The reasons why we need a stock market index are as follows:

Facilitates selection of stocks

There is a listing of thousands of companies on the exchange of a stock market. Choosing the right stock for investment may create havoc in your brain, appearing to be your biggest nightmare. 

You might not be able to tell the equities apart without a baseline. Sorting the stocks at the same time gets tricky. A stock market index operates as an instant differentiator in this case, and it categorises firms and their stock based on essential factors such as company size, sector, and industry type.

Representative of the market

Investing in equities entails risk, so being wise and careful is necessary. Individual stock research and investing in each stock may appear to be impractical. Indices aid in the filling of knowledge gaps among investors, and they depict the overall market or a specific market segment’s trend. 

The benchmark indices in India are the NSE Nifty and the BSE Sensex and are said to reflect the overall success of the stock market and act as a mirror to stock market performance. Like, an index made up specifically of pharmaceutical stocks is thought to represent the average price of pharmaceutical company stocks.

Metric for apple-to-apple comparison

It would be best to determine whether a stock is worth the investment before adding it to your investment portfolio. You can simply judge a stock’s performance by comparing it to the underlying index. The stock is deemed to have outperformed the index if it generates higher returns than the index. Contrarily, it is deemed to have underperformed the index if it produces lower returns than the index. 

You can also compare the index to a group of stocks, such as those in the information technology industry or the pharmaceutical industry. You can readily understand market patterns with the help of stock market index.

Reflects the emotions of investors

When you participate in equity markets, judging investor attitudes and gauging their sentiments becomes essential in addition to other factors. 

If you wish to invest in a specific stock, you must understand the dynamics that cause the price to climb or fall. It is because it impacts stock demand, which, in turn, affects the overall cost.

To invest in the appropriate stock, you must first understand why its price has risen or fallen and the fluctuations in price. Indices can assist investors in evaluating their sentiment at this point. 

Helps in Passive Investment

Investing in a portfolio of assets that replicates the equities of an index is known as a passive investment. Investors use index portfolios to save money on research and investment selection.

As a result, the returns generated from the portfolio will be similar to those of the index. If an investor’s portfolio mimics the Sensex, his portfolio will generate returns of about 8 per cent too, when Sensex generates returns of 8 per cent.

Types of Stock Market Indices

There are many types of indices in the Indian stock market that reflect the performance of stocks based on various classifications.

However, some of the most common Indian stock market indices are as follows:

Benchmark indices

These indices are the most popular ones in the Indian stock market. They are widely trusted for stock market evaluation by investors. Some examples of such indices are as follows:

• BSE Sensex
• NSE Nifty

Wide-coverage indices

These indices cover a large number of companies. Hence, giving a better overall representation of the stock market. Some examples of such indices are as follows:

• Nifty 50
• BSE 100

Market capitalisation indices

These indices represent the performance of a group of companies based on the size of their market capitalisation. Some examples of such indices are as follows:

• BSE Midcap
• BSE Smallcap

Sectoral Indices

These indices are representative of the companies based on particular sectors. Hence, they help investors evaluate the performance of a specific industry. Some examples of such indices are as follows:

• CNX
• IT
• Nifty FMCG
• S&P Oil and Gas
• Nifty Bank Index.

What is Sensex?

The term “Sensex” is a buzzword widely used in the stock market. It is called so because of Deepak Mohoni, an expert, who termed it “Sensex.” The BSE Sensex was initially released on January 1, 1986, in the Indian stock market and is regarded as the heart and soul of the stock market. 

Sensex, which is considered the combination of the terms sensitive and index, represents 30 companies listed on the BSE(Bombay stock exchange).

One of India’s oldest market indicators, known as the S&P BSE Sensex, is a BSE Sensex.

How do we calculate Sensex?

One method of calculating Sensex is the free flow method. The free-flow method calculates Sensex by considering the proportion of shares that can be readily traded. The BSE calculates the market value of all 30 companies whose stocks are traded, after which it derives a free-float factor. 

A company’s market capitalisation needs to be computed by multiplying the number of outstanding shares with its current pricing. The free-float market capitalisation value is divided by the base value or index divisor of 100 to get the value of the Sensex. It is worth noting that Sensex’s base value is 100.

The formula for calculating the same is as follows:-

Sensex = (Total free-float market capitalisation/Base market capitalisation) X Base Index Value.

What is Nifty?

The National Stock Exchange (NSE) index is another famous stock exchange in India, and the Nifty is a stock market index of NSE. 

Nifty 50 is a stock index that consists of 50 stocks. India Index Services and Products Ltd is in charge of IISL.

How do we calculate Nifty?

The value of Nifty, like the Sensex, is derived using the same method used to calculate Sensex. It is a free-float market capitalisation technique. To achieve free-float market capitalisation, a stock figure is multiplied by the Investable Weight Factor (IWF). 

Remember that the base value of Sensex is taken as 1000 on a daily basis. 

The current market value is divided by the base market capital and then multiplied by the base value, i.e., 1,000, to obtain the index value of Nifty. 

The following is calculated using the formula given below:

Nifty = (Current Market Value/Base Market Capital) X Base Index Value

Types of Stock Market Indices based on specific coverage

The several types of Indices based on the speciality of stock they cover are as follows:

Sectoral indices

Both the NSE and the BSE have indicators that measure the performance of companies in a specific industry. Hence, the indices that analyse a particular sector are called sectoral indices. 

For example, NSE Pharma and NSE Healthcare are indicators of their respective exchanges for the pharmaceutical industry. Nifty PSU Bank and S&P BSE are two examples, and PSU indices are indicators for all publicly traded banks. It is not required for both exchanges to have matching indexes for all sectors, but it is usually the case.

Benchmark indices

Benchmark indices are the premium stock market indexes basking in their glory concerning their trait of being the best indicator of a particular stock market. We have the S&P BSE Sensex, which comprises 30 best-performing equities, and the Nifty 50, which constitutes 50 of the best-performing stocks, are BSE and NSE indices, respectively. 

These indices are referred to as benchmark indexes because they are the most concise, apply the best methods to control their selected companies, and are the best indicators of how the markets perform.

Market-cap based indices

A few indices select companies only based on their market capitalisation. The market capitalisation of a publicly traded corporation, as we all know, is its market value. 

As defined by SEBI guidelines, indices like the NSE small-cap 50 and the S&P BSE small-cap are indices that only include companies with a lower/smaller market capitalisation. Other indices include the NSE midcap 100, S&P BSE midcap, etc.

These indices can cover all types of companies, from large-cap companies to mid-cap and small-cap companies, depending on the preference of the user.

How do you interpret a Stock Market Index?

In order to effectively interpret an index, one must understand the index value pattern and how it has evolved with time. 

But, for indexes with no past record, there is a predetermined value. This value is determined at the beginning date of the index by grouping the stock values of stocks forming the index. 

The index values help investors track rising, and declining stock prices.

Hence, the tracking facilitates the usage of starting points to measure index fluctuations. 

But, sometimes, it can be misleading. 

For example, if one index climbs 250 points in a day and another only rises 10 points, the first index might seem to perform significantly better. 

Still, there can be a significant difference between their actual value. 

Let us say if the first index began the day at 25,000 and the second index at 250, the gains for the second index will amount to be more significant in percentage terms than the first index. 

Therefore, if you invest in funds that track the index, a more considerable percentage gain indicates a larger reward for the investor. Hence, concentrating on percentages rather than point changes is preferable for the investors.

Furthermore, even the most widely followed stock market indices do not always reflect the market performance. 

Knowing which stocks make up an index can help you figure out which portions of the stock market are responsible for that index’s success and why other indexes are not performing as well as this index.

How is a Stock Market Index formed?

Each stock market index possesses its unique proprietary formula for deciding which firms or other investments to include and represent. Companies that acquire a high rank in the market capitalisation-based rankings or the total value of their outstanding shares are included in indexes that evaluate the performance of vast market groups. 

An expert committee might also choose these indices, or they might reflect all of the shares tradings on a specific stock market. After deciding which firms to include in the index, the index manager must establish how those companies are represented—this process is known as index weighting.

Index weighting helps us understand the impact of a firm on a particular index based on the category represented by the index. Depending on weighting, the firms included in an index can have the same effect as the other firm or a completely different result depending on the various factors like market capitalisation or share value.

The index weighting models given below are the most common index developing methods, and they are as follows:

Market-Cap Weighted

In a market-cap-weighted index, more prominently represented stocks with larger market capitalisation. Large firms have a more significant effect on the index’s performance because of this structure.

Equal Weighted

In an equal-weighted index, all components are treated equally. This means that whether a firm is extremely large or extremely tiny, its performance has the same impact on the index.

Price Weighted

A price-weighted index is used to allocate a non-familiar weight to each firm based on its current share price. Companies with higher share values have more significant clout in these indices regardless of their size.

Most Notable Stock Market indices globally

The Sensex and Nifty are the Indian stock market indexes, namely the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). 

There are numerous renowned international stock exchanges like the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ). It would be unfortunate if we missed knowing about the indexes of such premium stock exchanges.

Hence, some of the most notable stock market indices are as follows:

S&P 500

The S&P 500 is a substantial and diverse stock market index of 500 of the most widely traded stocks globally, particularly in the United States. It is an index at the epicentre of global financial activity. This index provides a good indication of market movement in the United States. 

This stock market index can also be substantiated as the capitalisation/free-float weighted index. Since its beginning in 1926, the index has averaged a 9.8% annual total return and compound annual growth rate, including dividends. It is promising and benefits the investors when speculating the American Stock Exchanges.

NASDAQ

Nasdaq, a US index also known as the National Association of Securities Dealers Automated Quotations Index, measures the performance of approximately 3,000 companies, including foreign companies. 

The NASDAQ is best known for most of the world’s technology titans. The world’s first electronic exchange and an online global marketplace operate 29 markets, one clearinghouse, and five central securities depositories.

The Dow Jones Industrial Average (DJIA)

The Dow Jones Industrial Average is one of the world’s oldest and most well-known indices, comprising 30 major companies listed on the American stock exchange. Prices of the index’s 30 stocks are added together and then divided by a divisor known as the Dow Divisor. 

The Dow Jones Industrial Average is a stock market index that has its average calculated through the price-weighted method. This average is essential for almost every investor looking to invest in the US Stock Exchanges.

Financial Times Stock Exchange (FTSE)

FTSE, also known as Financial Times Stock Exchange index, comprises 100 companies listed on London Stock Exchange. Many of these 100 firms are globally focused, so they may not be an appropriate indicator of how the UK economy’s performing.

This stock market index’s weighting method of share prices happens through market capitalisation. The index uses the market capitalisation of the respective companies with its index value, so larger firms have a more significant impact on the index than smaller firms.

How to invest in a stock market index?

Investment funds that track the performance of various companies and assets are regarded as a great way to invest quickly, efficiently, and affordably since they track the performance of major indexes. Many investment wizards, including Warren Buffett, swear by index funds and exchange-traded funds (ETFs), which give access to a ready-made diversified portfolio of stocks and bonds.

The best thing about investing in ETFs and index funds is that one can invest at any intensity they prefer with any brokerage of their choice.

Bottom Line

Stock market indexes are part and parcel of the financial world, and they are not just a plus but a must. 

Without them, the financial world would have been a shambles of investors constantly looking for excellent stocks to buy. The relevance of stock market indexes stems from the fact that they make investing simple for novice investors.

However, there is one red flag. Indexes lighten your burden and help you take the first step in the stock market by making investing simple. But, this is not the conclusion of the story.

The needs of every investor are different, along with the resources they have at their disposal. You could be investing in a way that will pay off in a few months, or it might take years to see any returns.  

Hence, when it comes to investing, you must do the remainder of the legwork on your own. The Sensex may include the finest 30 firms, but it does not guarantee they are the best 30 companies for you. 

You could have a low-risk tolerance, yet a stock on the Sensex could have a high-risk value. So, one needs to understand that the investment portfolios are not the same for everyone, and they differ according to the needs of the individuals. Hence, relying solely on indices might not be a piece of sound investment advice.

Introduction

What does the stock exchange mean?

Every investor has asked this question at the onset of their investment journey. But has there ever been a precise answer?

No.

The lack of clarity is why millions of people lose their money on the stock exchanges every day, and it is also why a chunk of people are scared to invest or trade on these stock exchanges.

Investors with crystal clear fundamentals of the stock exchange and a financial analysis backed by thorough background research of the company are the only ones that can profit off the stock exchange.

In this article, we have provided a detailed yet simple explanation of the stock exchange.

First, we will understand the stock exchange meaning to proceed with the basics.

Stock exchange definition

The stock exchange is an integral part of the stock market, and it is a market for trading financial instruments such as stocks, bonds, and commodities. The stock exchange promotes the exchange of financial instruments between dealers and targeted buyers. 

In India, a stock market must follow a set of rules and regulations set forth by the Securities and Exchange Board of India or SEBI. The said governing body protects investors’ interests while promoting India’s stock market. 

Only companies listed on a stock exchange are permitted to trade. Even if a stock is not getting listings on a reputable stock exchange, one can exchange or trade it in an over-the-counter market. However, such shares will not have a high value in the stock market.

But how did the stock exchange toggle into existence?

History of stock exchange

A quick ride into the history of the stock exchanges would look something like this:

• During the 1300s: Europe and Venice

The money lenders in Europe started selling debt issues to individual investors. The Venetians were the front runners in the field and would carry slate with client information, much like brokers in modern times.

• During the End of 1400s: Belgium 

International trade is picking pace at Antwerp, or Belgium as we know it now. Few bonds are made as merchants anticipate price rises while others buy goods in advance to sell them later at a profit after the price rise.

• During 1611: Amsterdam 

The Dutch East India company became the only company to facilitate trading activity on the exchange leading to the creation of the first modern stock trading in Amsterdam. Later, the Dutch East India Company remained the first publicly-traded company for many years.

• During the End of the 1700s: The buttonwood Tree Agreement

Buttonwood Tree Agreement was formed by a concise group of merchants who used to meet every day to sell stocks and bonds. 

This practice led to the formation of the New York stock exchange.

• During 1790: Philadelphia Stock Exchange

The financial sector of the U.S. started developing due to the formation of the Philadelphia Stock Exchange. It also helps the expansion of the country in the West.

• During 1896: DJIA

Twelve industrial companies were the main components that contributed to the initial development stage after forming the Dow Jones Industrial Average.

• During 1923: Poor Publishing

The Henry Barnum Poor’s company called Poor’s Publishing formed the early version of the Standard and Poor’s index. 

The index was formed in 1926 and tracked 90 stocks in the beginning.

• During 1929: Roaring 20s

The speculators made leveraged bets on the stock market while inflating prices throughout the decade of the Roaring 20s, only to face a stock market crash in the end.

• During 1941: S&P

Henry Barnum Poor’s company called Poor’s Publishing merged with Standard Statistics to form the Standard and Poor’s Index.

• During 1971: Another US Stock Exchange, NASDAQ

Another US Stock Exchange named, The National Association of Securities Dealers Automated Quotations, NASDAQ started trading this year.

• During 1987: Black Monday

Black Monday became a famous term when corporate buyouts in portfolio insurance facilitated price rises in the market till October 19.

• During 2008: The 2008 Recession

The busting of the housing market after a substantial boom and the proliferation of mortgage-backed securities in the financial sector led to a disaster stock market crash.

How does the stock exchange work?

A stock exchange is a platform that facilitates the purchase and sale of financial instruments like equities, commodities, and bonds. 

It is accountable for the interaction of firms and governments with the investors for investment purposes. 

In India, the stock exchange activities are regulated by the security and exchange board of India (SEBI). 

Hence, all the companies and entities have to register with this board in order to start trading on the stock exchange.

The stock exchange aids the availability of financial instruments after a company conducts its initial public offering (IPO).

The shares of a company are sold to the first set of shareholders in the primary market with the help of an Initial Public Offering (IPO).

After the floating of an IPO, the shares of that particular company are traded in the secondary market. 

The stock exchange mechanism for deciding the price of stocks is based on the demand and supply of stocks. 

The market function on an electronic limit order book automatically helps an investor match the market orders. The regulators also limit the buying and selling as per the market situation.

On the other hand, brokers are responsible for the placement of orders and hence play a critical role in the trading structure of the market.

In a primary market, premium investors or institutional investors can benefit directly from the company’s IPO through the benefits of direct market access.

However, in a secondary market, investors purchase shares after communicating with parties like the buyer and the broker. 

But, the ownership of a share is transferred after the mutual agreement on the price. This process is known as settlement, and it is the end step for purchasing securities in a stock exchange.

Functions of a stock exchange

The features of the Stock Exchange are as follows:

Acts as an Economic Barometer

The stock exchange acts as an economic barometer, indicating the state of the economy. 

The prices of shares reflect every major shift in the country and economy, and it keeps track of all significant and minute changes in stock values. 

It is rightly said as the economy’s pulse reflects the state of the economy.

Securities Valuing

The stock market aids in the valuation of securities based on supply and demand variables of the market forces and external economic situations in a country. When profitable and growth-oriented corporations issue listed securities, they are often valued higher. 

Securities valuation aids creditors, investors, and the government in their various roles, valuing creditworthiness, valuing stocks, imposing taxes, etc.

Contributor to Economic Growth

The stock exchange offers a platform for trading securities of multiple companies. This trading process involves continuous disinvestment and reinvestment, which provides opportunities for capital formation.

Increasing public awareness of equity investment 

The stock exchange assists in disseminating information about equity markets. The introduction of new issues attracts people to invest in securities, as various securities are traded on a stock exchange. 

Allows for healthy speculation

The stock exchange ensures demand and supply of securities and liquidity by allowing for healthy speculation of traded securities.

Facilitates liquidity

The stock exchange’s most significant duty is to provide a convenient and trusted platform for securities transactions. It provides investors with the assurance that their precious assets can convert into cash. Or in other words, the stock market offers investment liquidity. Investors need not worry about liquidating their investments as the stock exchange provides a platform where it can break down long-term investments into medium or short-term investments.

Better Cash Allocation

Profitable businesses will have their shares actively traded, allowing them to raise new and fresh capital from the equity market. The stock market assists investors in effectively allocating capital so that they can gain the most profit.

• Transactional Safety: Transactional safety is assured since securities traded on the stock exchange are listed with trusted payment gateways, and securities are listed after the company’s position has been verified. All companies listed must follow the regulatory body’s laws and regulations.
• Encourages saving and investment: The stock market is a significant source of investment in a variety of assets with higher yields. Investing in the stock market is a better option than gold and silver as an investment.

Features of a stock exchange

The features of a stock exchange are as follows:

Securities market

The stock exchange is an ensemble for various securities that corporate companies and government or semi-government companies can issue. The security is our boat and sold on the stock exchange.

Second-hand securities

The company has already issued the shares and securities that experienced trading on the stock exchange.

Regulation of trade

The stock market facilitates trade regulation by ensuring that the broker or exchange members are trading on the company’s behalf. They cannot purchase or sell shares on their accounts.

Restricted only to registered securities

The stock exchange includes securities of only listed companies.

Authorised Transactions

In a stock exchange, one can only make the transactions through authorised brokers and the members involved in the transaction.

Assurance

The stock exchange has stocks only of companies that the central government has recognised, giving the general public assurance.

Gauging metric

The stock exchange index is used to evaluate the performance of the stock of a company.

Rules and regulations

The Securities and Exchange Board of India (SEBI) has provided guidelines that include a set of rules and regulations mandatory to be followed while dealing with securities in the stock exchange.

How are share prices set on a stock exchange?

There are numerous ways to determine the share prices of stock market shares.

The most renowned process is the auction process. In this process, the buyers and sellers execute the bidding and place offers for buying and selling.

In bidding, the buyer needs to bid a price at which they desire to buy the shares. 

In the offer process, the seller places a suggestion or ask, which is the price at which the seller is willing to sell their shares.

The trade can be executed if the bid and ask are the same amount after mutual negotiation.

The stock market comprises millions of investors, and each of them has different ideas about the value of a particular share.

The massive number of purchases and sales made by these investors every minute forms a stock exchange trading day.

The stock exchange provides easy trading, and any average person can access the stock exchange, and all they would need is a stockbroker.

If there is a mutual agreement concerning bid and ask, investors can complete their transactions with the help of a stockbroker.

Merits of being listed on the stock exchange

A company can avail of substantial benefits by getting listed on the Stock Exchange. Some of those benefits are as follows:

Upgrading credibility 

Investors consider stocks listed on a respected stock market to have a higher worth. 

Companies can profit from their stock exchange market reputation by increasing their number of shareholders, which adds to the company’s credibility. A powerful technique for growing the number of shareholders is to issue shares for their purchase. 

Low-cost capital financing

One of the most efficient ways for a firm to obtain low-cost financing is to issue company shares on the stock exchange market for purchase. Listed companies can raise more funds through share issuance due to their stock exchange market reputation, making it a lot easier, which they can leverage to keep their company afloat and activities running.

Backed by collateral 

Almost all lenders accept collateral and provide loans in exchange for securities. Because they see it as more reliable in the stock exchange market, a listed company is more likely to receive a faster clearance for their credit request. 

Also, vendors accept listed securities as a payment method in kind.

Liquidity 

Listing allows stockholders to benefit from greater liquidity than their rivals and provides them with immediate marketability. It enables shareholders to estimate the value of their investments. 

It also allows for share exchanges with a corporation, which helps balance off the risks and aids shareholders in increasing their profits from even the smallest growth in the company’s overall valuation.

Fair prices

In a stock exchange in India, the quoted price also represents the actual worth of a particular security. Because market forces and various external factors also determine the prices of listed securities, they are publicly disclosed. It can assure investors of cracking a good deal at prevailing fair market prices.

Demerits of being listed on the stock exchange

There is also a flip side to getting listed on the stock exchange. The demerits of getting listed on this Stock Exchange for a company are as follows:

Public eye

Public companies are constantly in the public eye because they are under the scrutiny of the public. The general public and investors expect these companies to follow the rules of the markets. They face constant scrutiny and are expected to be accountable for all the actions happening in the company’s name.

Risk of getting undervalued

When a company issues shares, it dilutes its ownership and restricts its liquidity to market forces. A negative drift of market forces concerning the company can affect the fundraising and acquisition activities of the company.

The market can cause this mishap because the company might be experiencing a lack of demand, resulting in a low share price, eventually making the company lose its appeal. In stock exchanges, a company’s share price is not affected by companies performance but by the market and economy’s performance.

Cost

The flotation and ongoing listing can be expensive, and one should not underestimate the management time and cost required during such listings. The whole flotation process is very time-consuming because of its regular and constant administration announcements and labour-intensive dealings.

Different ways to invest in the stock exchange

An investor can invest in the stock exchange in India through two different methods.

The first method is through the primary market, and the second method is through the secondary market.

Primary market

The primary market is a platform where the companies issue new securities that do not previously exist in any other exchange. Companies use the primary market as a platform to float their new stock options and bonds for acquisition by the general public. If a company is investing its shares for the first time, it will be doing that through methods like IPO in the primary market.

Secondary market

The general public commonly refers to the secondary market as the stock market. Investors use the secondary market as a platform to purchase and sell the stocks of other companies. 

The companies have no role in buying and selling stocks in the secondary market.

Brokers facilitate the trading of shares for investors without involving the company that issued them in the first place.

The shares are available in the secondary market only after they have gone for an IPO in the primary market.

After the shares make their way from the primary market to the secondary market, the company does not involve itself in the transactions related to the trading of these shares.

There are two types of secondary markets:

• The auction market and, 
• The dealer market.

What are the notable stock exchanges in India?

There are two significant Stock exchanges in India. The first one is the National stock exchange, also abbreviated as NSE, and the second is the Bombay Stock exchange, also abbreviated as BSE.

National Stock Exchange (NSE)

The National Stock exchange is a stock exchange market established to eliminate the monopoly of the Bombay Stock Exchange on the stock market arena in India.

The establishment of NSE happened in 1992 in Mumbai. The NSE is among the front runners in India’s demutualised electronics stock exchange markets.

The National Stock Exchange market capitalisation as of August 2018 was estimated to be around 2.27 trillion US dollars. The National Stock Exchange is also the 12th largest stock exchange globally.

Nifty 50 is the index of the National Stock Exchange, and it is heavily used by investors worldwide to assess the performance of the Indian capital market.

The National Stock Exchange has a public listing of around 4000 companies.

Bombay Stock Exchange (BSE)

Bombay Stock Exchange is the world’s 10th largest stock exchange, established in Mumbai in 1875 at Dalal Street. This stock exchange is said to be the oldest stock exchange in Asia. The Bombay Stock Exchange market capitalisation as of 31st March 2018 happens to be 2.3 trillion US dollars.

The Bombay Stock Exchange has a public listing of around 6000 companies.

Sensex is the index of the Bombay Stock Exchange and is used by investors to estimate the performance of the Indian capital market.

The Bombay Stock Exchange was at an all-time high in June 2019 at 40,312.07.

What are the criteria for listing in the India Stock Exchanges?

If a new company desires to get listed in the Indian Stock Exchanges, then some requirements that it needs to abide by are as follows:

• The company must be incorporated under the Companies Act, 1956/2013.
• The company should not have more than INR 25 crores as its paid-up capital or face value.
• The net worth of the company should be positive.
• The company should have Net Tangible Assets of at least INR 1.5 crore.
• The firm or the partnership converted into the company should have at least three years of track record.
• The company should have a website.
• There should be an agreement of the company with both the depositories and the company should also aid trading in Demat securities.
• The company should not change its promoters until one year from filing the application in the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE) for its listing.

NOTE – The list only provides an overview of the criteria and is not exhaustive in nature.

Significant stock exchanges worldwide

Some of the most notable stock exchanges around the world are as follows:

New York Stock Exchange (NYSE)

New York Stock Exchange (NYSE) is the largest stock exchange in the World. 

It was founded in 1972 and had a 23.12 trillion US dollars market capitalisation as of March 2018.

The New York Stock exchange is based at 11 Wall Street, New York City, USA. It allows the purchase and sale of various financial instruments like exchange-traded funds (ETFs), equity, bonds, etc.

National Association of Securities Dealers Automated Quotations (NASDAQ)

The NASDAQ is an American Stock Exchange in New York City founded in 1971. It ranks second in the list of stock exchanges sorted by market capitalisation. 

The New York Stock Exchange (NYSE) acquires the first place. The NASDAQ is located at 151 W, 42nd Street, New York City.

The surprising fact about the Nasdaq stock exchange is that there are no companies from the Oil and Gas sector or utility sector on this exchange. This Stock exchange is famous for companies that provide healthcare and consumer services and tech and growth firms.

Shanghai Stock Exchange (SSE)

Founded in 1886, adjourned in 1949, and re-founded in 1990, The Shanghai Stock Exchange (SSE) is the biggest in Asia. It is also the third-largest stock exchange globally, with around 1450 listed companies.

The Shanghai Stock Exchange has a market capitalisation of 7.63 trillion US dollars. This stock exchange is different from other stock exchanges because it does not have market regulators to impose circuit breakers to restrict the price volatility. 

Instead, in case of negative news leading to a market crash, the Chinese government can ban trading for that day. 

Other prominent Stock Exchanges in the list of Top 10 stock exchanges are Euronext, Tokyo Stock Exchange (TSE), Hong Kong Stock Exchange (HKSE), Shenzhen Stock Exchange, and London Stock Exchange (LSE).

The other two on the list happen to be National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) in India.

What do companies need to comply to get listed on the most notable stock exchanges?

All companies that want to go public must comply with specific reporting standards set forth by their respective securities regulators. 

The Securities and Exchange Commission in the United States mandates that firms discuss and publish their financial statements and make other disclosures. These are available in quarterly and annual reports. 

In addition to these requirements, a firm must meet the stock exchange requirements it wishes to be listed. 

Below are some of the stock exchange requirements for a firm to be listed. For initial public offerings, the listing requirements may vary (IPO).

The requirements for listing in the top three stock exchanges of the world are as follows: 

NYSE (New York Stock Exchange)

• For the previous three years, pre-tax income must have been at least US$10,000,000. 
• The market capitalisation of publicly traded securities must be at least $100 million. 
• The number of publicly traded shares must exceed 1,100,000. 

National Association of Securities Dealers Automated Quotations (NASDAQ)

• For the previous three years, pre-tax income must have been at least US$11,000,000. 
• A public company’s market capitalisation must be at least US $45,000,000. 
• The number of publicly traded shares must exceed 1,250,000. 

 Shanghai Stock Exchange (SSE) 

• The Shanghai Stock Exchange requires a minimum capital stock of RMB 50,000,000. 
• The company must issue at least 25% of all shares in case the company’s capital stock exceeds RMB 400,000,000. Else, it must publicly issue 10% of all shares. 
• There have been no significant legal violations or fake records in the company’s financial reports in the last three years.

Note: This is an overview of the requirements, and the list is not exhaustive in nature.

Final thoughts

A stock exchange is the essence of a country’s economy. Investment experts and financial analysts often use insights into the stock exchange’s performance to gauge the financial health of a nation.

The stock exchange allows millions of investors to purchase shares from premium companies. 

Overall, the stock exchange is the backbone of public companies for capital generation and the go-to option for investors.

Introduction

If you are thinking about investing in a company or business as shareholder equity, then it is time to know everything about it before jumping into the ocean. 

Shareholder equity or share capital is primarily the owners’ claim on the company assets after all debts get settled. The remaining earnings are a part of the shareholder equity, like any other capital invested into the business. It will allow investors and analysts to decide the company’s financial ratio values. It will offer them the best tools to make well-informed and better decisions. 

Shareholder equity consists of two components. One is the capital invested in the business through preferred and common shares after the initial payment. Second is the retained capital and the total earnings not distributed among the shareholders for years. The account also demonstrates what the company will do with the capital profits and investments during the period.

Shareholder equity also reflects the business dividend policy for paying the profits earned as dividends to the shareholders. You can also reinvest the profit capital back into the business. The accountants break shareholder equity into three categories: retained, preferred, and common shares, which appear together with the assets and liabilities of the company. 

What is Shareholder equity?

In layman’s terms, shareholder equity is the total capital amount in a company that directly connects to its owners. Shareholder or stockholder equity can be either positive or negative. 

Negative stockholder equity refers to the circumstance where the shareholders will not receive any amount after liquidating all the assets and paying off the remaining debts. On the contrary, in positive stockholder equity, the business assets will exceed the liabilities. It indicates that the business includes enough assets to meet different liabilities.

Investors always remain away from companies with negative shareholder equity as they are highly risky to invest their money. Shareholders might not also get a proper return on equity if this state continues. If the company liquidates the assets in a negative shareholder condition, the assets will become helpful in paying the current debts. 

Shareholder equity compares the total capital invested in a business versus the returns the company has created during a particular time. You can find all the information to calculate shareholder equity on the balance sheet. Calculate the total asset value hassle-free by checking out the total non-current and current assets. 

Current and Non-current Assets

Current assets are those properties that you can convert rapidly into cash, usually within a year. It can include various assets like stock, cash, and accounts receivable. Non-current assets are long-term properties that can create more profit over a year and include buildings, vehicles, trademarks, and many more. 

Example of Shareholder Equity

Let us now look at an example of shareholder equity and how it works. Assume that ABC company includes a total asset of Rs. 30 lakhs and a liability of Rs. 24 lakhs. In this case, the shareholder equity will be 6 lakhs. 

Shareholder equity formula and calculation

You can calculate the shareholder equity with the help of the following two formulas.

Formula 1

Shareholder’s equity = Total (Assets-liabilities)

This formula is called the basic accounting equation and is relatively easier to use. You have to add the assets present in the company balance sheet and subtract the summation of the liabilities. Total assets will indicate the existing properties of the business like marketable securities, prepayments, and long-term assets like fixtures and machinery. You can acquire total liability by adding the long-term and the current liabilities. 

All the necessary metrics are present in the balance sheet of the company. The remaining after deducting the total liabilities from the assets are the total value shareholders will have after repaying all the outstanding debts.

Formula 2 

Stockholders equity = retained earnings + share capital –Treasury stock.

This method is called the investors’ equation. This formula will sum up the company’s retained profit and the share capital and subtracts the treasury shares. Retained earnings are the addition of the company’s cumulative earnings after paying the dividends. It is present on the stockholder equity segment of the balance sheet. 

Treasury stocks are nothing but the repurchased share of the business that includes the potentiality of reselling to the investors. It is the difference between the outstanding share and the share offered for subscription by the company. 

Return on Equity

It is a measure that most analysts use to decide how a company can efficiently implement equity to create a profit. You can acquire this calculation by taking out the net business income divided by the stockholder equity. You can obtain the net income by subtracting the total revenue from the taxes and expenditures a company creates for a particular period. 

If you evaluate the business return on equity for many years, it will show a current trend in the company’s earnings growth. For instance, if a business reports a return on equity of 12% for many years, it is a good sign as the company can continue to grow and reinvest 12% into the future. 

Components of shareholder equity

Corporate accounting experts and investors analyse the shareholder equity to decide how a company manages and uses initial investment. It also helps to determine the valuation of the company. There are different shareholder equity components which are as follows.

Outstanding shares

The total number of outstanding shares is an integral part of the shareholder equity. You can calculate outstanding shares as the total number of business stocks sold to the investors, and the company cannot repurchase them. Outstanding share also represents the total stock number the business has issued to the public investors, company insiders, company officers, and more. 

The total amount of outstanding shares includes common stock par value and any preferred shade par value the business has sold. Outstanding shares are also an integral segment of other calculations like earnings per share and market capitalisation. 

Additional paid-in capital

Shareholder equity includes the total money paid for the stock shares and is known as additional paid-in capital. You can derive this figure from the difference between the common par value, the preferred stock, the price at which the company has sold each share, and the newly sold shares. 

There is an additional paid-in capital when any investor buys the shares directly from the company. It also represents the extra amount the investor has to pay for the company share over the shares’ face value during the initial public offering of the business. Additional Paid-in capital is present in the equity segment of the business balance sheet. 

For example, suppose a company issues 10 lakh shares at Rs 120, but the book value is Rs 100. Here, each share is being issued at a premium of Rs 20. Therefore, the additional paid-in capital would be Rs 20 x 10 lakh = Rs 200 lakh.

Retained Earnings

RE or retained earnings are the company profits that do not get distributed as dividends to the shareholders. These are allocated for investing back into the company. You can use the retained earnings for funding working capital, debt servicing, purchasing fixed assets, and many more. You can calculate the retained earnings when the beginning balance of retained earnings is added to the net loss or income and subtract the dividend payouts.

The business also maintained a retained earnings statement outlining different changes in the retained earnings for a particular time. The formula for calculating retained earnings is as follows. 

Retained earnings = starting period retained earnings + Net loss or income – cash dividends –stock dividends.

The business refers to the retained earnings as the retained surplus or the retention ratio.

Treasury Stock

Treasury stock is the share numbers the company has repurchased from the investors. A business always holds its stock in the treasury for later implementation. It can also sell the stocks shortly to prevent a hostile takeover or raise capital. Treasury stock decreases the total stockholder equity on the business balance sheet. It represents a tiny number of available shares for the investors when they again repurchase them. 

A business will always list its treasury stock as negative in the balance sheet equity segment. It is also known as reacquired or treasury shares. Treasury stockholders do not get dividends and get excluded from the earning per share calculation. 

Share Capital

Share or contributed capital refers to the amount received by the company from the shareholders’ transactions. Businesses usually issue either preferred or common shares. Common shares are the residual ownership in a business. During dividend payment or liquidation events, common shares only receive the payments after preferred shareholders get the payment first. 

If a company issues 10000 common shares for Rs. 30 each, the contributed capital will be Rs. 30000. Then the journal entry will be:

DR	Cash in rupees	3,00,000
CR	Common shares	3,00,000

It is also common to see businesses selling subscription-based shares to the stockholders. In these circumstances, the buyer can make a down payment on buying a specific number of shares and agrees to pay the remaining amount later.  For instance, if a company sells 10000 common shares for Rs. 10 each on a subscription where the buyer has to pay Rs. 3 for every share while signing the contract and the remaining amount two months later, then the entry in the balance sheet will be:

DR	Cash in rupees	30000
DR	Share subscription receivables	70000
CR	Common share subscribed	100000

The receivable functions of the share subscriptions are the same as the accounts receivable. Once the buyer has paid the receivable amount in full, the subscription account of the common share gets closed, and the company issues the shares to the buyer.

DR	Cash in rupees	6,00,000
CR	Share subscription receivables	6,00,000
DR	Common share subscribed	1,00,000
CR	Common shares	1,00,000

Dividend Payments

Dividend payments to the stockholder by the company are fully discretionary. Companies do not have any obligation to pay dividends until the board has formally declared anything. There are four dates for dividend payments. Out of which two need particular accounting treatments for a journal entry. There are different dividend types in which companies compensate their stockholders. Among them, stock and cash are the most prevalent ones.

Date	Journal Entry	Explanation
Declaration date	DR retained earning CR dividends payable	When the board declares the dividend, the company have an obligation to pay through a dividend payable account
Ex-dividend date	No entry	It is a date when a share trades with no right to receive a declared dividend, before this date, an investor will have no dividend.
Record date	No entry	When the company compiles a shareholders list for receiving the dividends.
Payment date	DR Dividends payable CR cash	When cash or other dividend form is paid to the shareholder.

Equity Derivatives

The capital account lists some equity derivatives, which are securities converted into stock. It can be convertible stock warrants and preferred shares. For instance, stock warrants are the long-term alternatives to preferred or common stock. A warrant can give the owner the right but not the obligation to purchase a share set on or before the expiration date at a specified price. This cost is called the exercise price. The capital account value for warrants is equal to the exercise prices multiplied by the number of times the shares for every warrant. 

AOCI or Accumulated other comprehensive Income

The AOCI account is within the equity segment of the shareholder balance sheet. It reports a special income class not included in the net income. The income type included in the AOCI account is still to be concluded. 

Examples of AOCI accounts are the profit from the unrealised transaction from foreign country transactions and security investments’ current value in other companies. When someone closes an AOCI transaction, the business transfers the value from the equity section of the shareholder balance sheet to the income statement. 

Use and Importance of shareholder equity

The shareholder equity on a financial statement like a balance sheet or retained earnings indicates an investor or a regulator investment in a company. You can calculate the shareholder equity on a financial state at any given time, yearly or quarterly. Investments prefer companies as investment vehicles. Businesses offer liability shielding, making it relatively easier to sell and buy shares. Due to this reason, business owners who want to raise capital most often select the corporate structure. Now let us quickly look into the use and importance of shareholder equity below.

Reporting purposes

Stockholder equity is a significant indicator of the financing sources of a business. It indicates whether the company is borrowing funds for its operation or relying on its capital from the investors. It also assists the top management in understanding the dividend payments that the company sends to the investors. An investor buying the preferred or common stock of a business can become a stockholder. 

Reporting the time frame

A company can report the stockholder equity after a specific period like monthly, quarterly, or yearly. GAAP or Generally Accepted Accounting principles require a company to issue a complete financial statement set for showing corporate profitability and shareholder equity. The financial statement includes a profit and loss statement, cash flow statement, retained earnings statement, and a balance sheet. 

Effect on the balance sheet

A company can report stockholder equity on a balance sheet according to GAAP. It is related to the investments from two shareholders, type-preferred and common. Common shareholders are investors buying regular or common shares when the price increases. Preferred shareholders are the ones who like to purchase preferred shares. Preferred shareholders can enjoy similar privileges as the common ones but after receiving the dividends before common shareholders. 

Effect on the retained statement 

The amount of stockholder equity on a retained earnings statement is related to the equity balance of the shareholder at the starting period, net income, dividends paid during a period, and the equity balance of the shareholder at the term-end.

Shareholder equity is a vital figure necessary for investment purposes. If the stockholder equity is positive, the company has enough assets to cover the liabilities. However, when it is negative, the only reason is debts have to outweigh the assets. If the negative shareholder equity extends for long, the company might face solvency issues.

Bottom line

Shareholder equity indicates how a business creates a profit by implementing ratios like ROE. The company’s net income gets divided by the shareholder equity to measure the balance between investor profit and equity. It is used in financial modelling to forecast the future items on the balance sheet, depending on the past performance. 

Introduction

A capital market is a planned market, which is further classified into primary and secondary markets, each serving its specific purposes. 

The Secondary market is the platform used for trading securities already issued by the primary market, and it allows all scales of investors to buy and trade securities. 

Though the secondary market facilitates the trading of both equity and debt, it is mainly used for equity. 

The equity or stock market has a substantial presence in the secondary market. It is the intelligent investor’s secret for quick and significant returns. 

But, to fare well in the equity market, one first needs to master the secondary market meaning. 

So, without any further ado, let us take you through the fundamentals of the secondary market, starting with the secondary market definition.

What is the Secondary Market?

A secondary market is a platform that facilitates the trading of shares of multiple companies amongst investors. Secondary markets consist of both equity as well as debt markets.

It means that the investors can freely buy and sell the shares without the company’s intervention that issues them. 

The value of a share is based on the performance of the company. Income in this market is generated via the sale of the shares from one trader to another. Though stocks are the most commonly traded securities, there are many other types of secondary markets. 

For instance, investment banks, corporate companies, and individual investors buy and sell mutual funds and bonds on the secondary markets.

Secondary market transactions are termed secondary just because one step is removed from the trade that created the securities in question. 

For instance, a financial institution that writes a mortgage for a customer creates mortgage security. The bank then sells it to Fannie Mae in the secondary market in a secondary transaction.

Entities in the Secondary market

The various entities that are functional in the secondary market include –

• Retail investors.
• The Advisory service providers and brokers comprise the commission brokers and the security dealers, among others.

Different options in the Secondary Market

The Different Instruments in the Secondary Market are as follows:

The instruments traded in a secondary market consist of the fixed income instruments, the variable income instruments, and the hybrid instruments.

Fixed income instruments

Fixed income instruments are debt instruments that ensure a standard form of payment, such as interests, and the principal is paid back on maturity. Debentures, bonds, and preference shares are examples of fixed-income securities.

Debentures are financial instruments that are primarily categorised as debt instruments.

Any type of collateral does not secure these securities. Therefore, returns generated from debentures are dependent on the issuer’s credibility.

As for the bonds, they are effectively a contract between two parties, whereby the government or the company issues these financial instruments. As investors buy the bonds, it lets the issuing entity secure many funds. Investors get interests at fixed intervals, and the principal is paid back on maturity.

Individuals who own a company’s preference shares receive the dividends before the payments are made to the equity shareholders. 

If a company faces bankruptcy, preference shareholders are paid before the other shareholders.

Variable income instruments

Investment in the variable income instruments brings about an effective rate of return to the investors. The various market factors help determine the quantum of such returns. These securities expose the investors to higher risks and higher rewards simultaneously. Examples of such variable income instruments are – derivatives and equity.

Equity shares are those instruments that allow a company to raise finances. Also, investors holding equity shares have a specific claim over the net profits of a company and the assets if the company is liquidated.

As far as derivatives are concerned, they refer to a contractual obligation between the two parties involved in paying off the stipulated performance.

Hybrid instruments

Two or more financial instruments are joined to form a hybrid instrument in these instruments. Convertible debentures are an example of hybrid instruments.

Convertible debentures are available as a loan or as debt securities. These debentures have 

the option of being converted into equity shares.

Properties of the Secondary Market

The functions of the secondary market are as follows:

Facilitates investment

The stock exchange provides a platform for the investors to enter into trading transactions of bonds, shares, debentures, and other such financial instruments in the form of secondary markets.

Allows trading from anywhere

Transactions can take place at any time. The market provides for active trading so that immediate purchase or selling with slight variation in price among different transactions can occur. Also, there is a continuity in trading, which enhances the liquidity of the traded assets in the market.

Facilitates liquidation of securities

Investors finds good platforms, such as an organised exchange, to liquidate their holdings. The securities that are held can be sold in various exchanges.

Medium for price determination

A secondary market also acts as a medium for determining the pricing of multiple assets in a transaction that is consistent with the demand and supply. The information about these transactions’ prices is provided within the public domain and enables the investors to decide accordingly.

Barometer for economy’s performance

It is also indicative that a nation’s economy serves as a link between savings and investment, which implies that the savings are mobilised via investments through securities.

Types of Secondary Market

Secondary markets are generally of two types – Stock exchanges and over-the-counter markets.

Stock exchanges

Stock exchanges are centralised platforms where securities trading takes place by direct contact between the buyer and the seller. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are two examples of such platforms.

Transactions in the stock exchanges are subject to stringent regulations in securities trading. 

A stock exchange is a guarantor itself, and the counterparty risk is negligible. It can obtain such a safety net via a higher transaction cost levied on investments in the form of commissions and exchange fees.

Over-the-counter (OTC) market

Over-the-counter markets, unlike stock exchanges, are decentralised, comprising participants that engage in trading amongst themselves. 

Over the counter, markets are subject to higher counterparty risk since parties deal directly with each other, and there is no regulatory oversight. 

Foreign exchange markets (FOREX) serve as an example of an over-the-counter market. There is tremendous competition in an Over The Counter market to acquire higher volume. 

Due to this, the securities’ price differs from one seller to another.

Auction and Dealer markets

Apart from the stock exchange and the Over The Counter market, other secondary markets include the auction and dealer markets.

The former serves as a platform for buyers and sellers to negotiate and then arrive at an understanding of the rate for trading securities. This information is related to the pricing and is put out in the public domains, including the offer’s bidding price.

The dealer market is another secondary market where various dealers decide the prices of specific securities regarding a transaction. Foreign exchange and bonds are typically traded in a dealer market.

Examples of Secondary Market Transactions

All types of investors benefit from secondary market transactions because they supply liquidity, and their costs significantly decrease due to the enormous volume of transactions.

The following are a few secondary market examples of securities trades.

• In a secondary market, investors trade securities with other investors rather than the issuer. If investors wish to purchase Larsen & Toubro stock, they must do so via another investor who holds such stock rather than from L&T directly. As a result, the corporation will be excluded from the deal.
• Individual and corporate bond buyers, sellers and investment banks participate in the bond market.

How is the secondary market different from the primary market?

A key difference in the primary market is that a primary market is only concerned with the transactions where the issuing company issues a public offering to the investors for the first time. Further selling of those same shares takes place in the secondary market.

To get a detailed understanding of how the primary market differs from the secondary market. 

Let us provide a detailed comparison chart comparing the primary and secondary markets.

S.no.	Basis	Secondary Market	Primary Market
1	Definition	The secondary market is where the securities are traded among the investors. A share comes to the secondary market after being issued in the primary market.	The primary market is where the securities are traded directly from the issuing company to the investors, and it is the place where securities are sold to first-time investors.
2	Synonymous names	The secondary market is also known as the aftermarket.	The primary market is also known as the new issues market.
3	Parties involved in the trade.	The buying and selling of securities happen among the investors only.	The buying and selling of securities happen between the investors and issuing companies.
4	Fund providing	The secondary market does not allow companies to raise funds for their ventures.	The primary market allows a company to raise capital for its business ventures, and it aids in finance for a company’s expansion and growth.
5	Intermediary	Brokers are the intermediates in a secondary market.	Underwriters are the intermediates in a primary market.
6	Fluctuation in price.	The secondary market prices depend on demand and supply, and hence, there are tremendous fluctuations in the costs of the secondary market.	The primary market has fixed prices. Hence, there are no fluctuations in the primary market.
7	Variety of instruments	The secondary market has a plethora of options. There are various products for an investor in the secondary market.  Some of these products are shares, debentures, derivatives and warrants. However, that is not all. The secondary market is a potpourri of financial instruments.	The primary market does not entertain variety in its securities. The market has limited options: initial public offerings (IPO) and follow-on public offerings (FPO).
8	Purchase.	The investors do not get involved with the issuing company in the secondary market while purchasing securities.	In a primary market, the investors purchase securities directly from the issuing company.
9	Transactional frequency	The secondary market has no limit to selling and purchasing security, and investors can do it as many times as they want.	In a primary market, the investor can invest only once in a market for a particular security, and the sale and purchase are limited to the primary market.
10	Beneficiary	The investor is the beneficiary in the secondary market.	The company is the beneficiary in a primary market.
11	Structure	The secondary market has a well-formed structure and an organised set-up.	The primary market does not have a structure, so it is not organised.
12	Regulations	The secondary market has guidelines provided for the investors. Investors need to follow the guidelines given by the stock exchange and the government.	If a company decides to issue shares in the primary market, it needs to follow all the guidelines provided by India’s Security and Exchange Board.
13	Interference	A secondary market does not experience any government interference.	A primary market experiences government interference during the issue of shares by a company.
14	Advantage	A secondary market is beneficial for booking profits for an investor.	A Primary market is beneficial for fundraising for a corporation or government.
15	Disadvantages	A substantial disadvantage of the secondary market is the losses incurred by the investors due to fluctuating prices.	A substantial disadvantage of the primary market is its time-consuming and expensive methodology.

Advantages of a secondary market

Following are some of the advantages of a secondary market:

• Secondary markets allow investors to save as well as invest, allowing them to earn a profit.
• It provides a possibility for quick and significant gains in a short period of time.
• Because investing does not necessitate a large sum of money, it is feasible to do so with a modest sum of money.
• Stock prices on the secondary market aid in the accurate valuation of a company.
• It is a good measure of a company’s economic health because falling or rising prices indicate a recession or a boom in the economy, respectively.
• It is simple to sell or acquire securities, ensuring an investor’s liquidity.
• The mobilisation of savings becomes easier when money is held in shares.
• Even if it is a minority and extremely small company, investing in its shares offers you a sense of ownership.
• Aside from serving as an investing platform, the secondary market also provides complex financial advice. Investment counsellors and stockbrokers, for example, are significant participants in this area.
• Even minority ownership permits you to vote and speak out at general meetings in several companies.
• The owners of a corporation whose shares are exchanged on a secondary market are known as shareholders. It tends to strengthen company governance since management must account for all actions in front of shareholders.

Disadvantages of a Secondary Market

Now, let us look at the flip side of the secondary market. Some of the disadvantages of secondary markets are as follows:

• Prices fluctuate in secondary markets, and the market’s unpredictability can result in a quick and unexpected loss.
• Because an investor must first execute specific requirements before purchasing or selling in secondary markets, it is time-consuming.
• Government policies can frequently act as a roadblock and mislead market participants. This causes significant interruptions, with businesses suffering the brunt of the losses and damage.
• The risk is more significant because the market is influenced by a range of external factors that can lead it to trend upward or downward in minutes.
• A brokerage commission must be paid when an investor decides to buy or sell shares. Simply put, it lowers profit margins.

How to trade in the Secondary Market

Here is a step-by-step guide to let you in on some insights about how to trade in the secondary market. The steps explaining how to deal with secondary market trading are as follows:

STEP 1: First, open a Demat account: 

To invest in the stock market, one must firstly open a Demat or a brokerage account. One cannot trade in the stock market without opening a Demat account. The Demat account works similar to a bank account, meaning that it holds funds for trading. Furthermore, the purchased securities are stored in an electronic Demat account.

STEP 2: Recognising the stock quotes: 

The stock price fluctuates in response to the news, the fundamentals, and the technical analysis, amongst other factors. You can work on your understanding of stocks and the markets by studying these topics, and they will assist you in understanding the best price at which you should enter or quit a trade.

STEP 3: Bids and asks: 

A bid price is the highest amount an individual is willing to buy a stock, and the asking price is the exact opposite of the bid price. A number represents the minimum price at which the seller will sell the shares. It is critical to pick the correct bid and ask prices in order to achieve a profitable trade.

STEP 4: Stock fundamental and technical knowledge: 

In order to plan your trade, you must study the various primary and technical evaluations of the stock. Fundamental analysis is a technique to determine the intrinsic value of a security, and it considers many factors, such as the company’s earnings, assets, and obligations. On the flip side, technical analysis analyses a stock based on the historical price and the volume chart to forecast the future potential of the stock.

STEP 5: Learn to avoid losing money: 

The stock market is known for its volatility. As a result, a newcomer must understand how not to lose a lot of money. To limit their losses, one must set a stop-loss price while completing a trade. If a stop loss is not in place, they risk losing money.

STEP 6: Consulting a professional:

The stock market is highly volatile and unpredictable, and nobody can precisely tell you the stock price. However, getting assistance from a professional might help beginners make better trading decisions, and they assist you in making the best possible decision.

STEP 7: Begin with safe stocks:

A large amount of capital loss upfront may lead to a loss of confidence. Starting with the less volatile stocks is a great idea. It is reasonably possible that you will not make significant profits initially. However, on the upside, you can maintain good performance even when the going gets difficult.

Investing can be challenging, taking into account the stock market’s volatility. However, opening a Demat account is the first step that one can take toward trading success. 

Next, one needs to work on acquiring a thorough understanding of the market, and in the long run, this will generate significant profits. 

How are Secondary Markets linked to Economic Efficiency?

The most common capital assets related to secondary markets are stocks and bonds. It doesn’t take long, though, to develop a variety of secondary markets.

There is a secondary market for used cars. Consignment shops and clothes retailers like Goodwill are examples of secondary marketplaces for clothing and accessories. Ticket scalpers offer secondary market deals, and eBay (EBAY) is a vast secondary market for many types of items. After banks package mortgages into securities and sell them to investors, they are sold on the secondary market.

In a market economy, the value of an asset changes with time, resulting in secondary markets. These movements are influenced by various reasons, including technology, human tastes, depreciation and upgrades, and a host of others. 

Traders in the secondary market are almost, by definition, cost-effective. Every non-coercive transaction of a good involves a seller who values the item less than the price and a buyer who appreciates the item more than the price. Both parties benefit from the transaction. When buyers and sellers compete, ask and bid prices collide at the purchasers who place the highest value on the things according to demand.

Economic efficiency refers to the allocation of resources to the highest valuable aim. In the past, secondary markets have decreased transaction costs, increased trading, and encouraged improved market information.

Bottom Line

Ambitious and risk-taking investors looking for opportunities that will help them achieve significant growth should have secondary market investments as their go-to option.

Secondary markets are the barometers to assess the performance of an economy. The demand and supply mechanism provides limitless opportunities.

So, open a Demat account and swiiiiiiissshhhhhhhh your way into stock market investing.

Introduction

When a stock’s market value is lower than its true value, it is considered an undervalued stock. Investment in such stocks is rewarding. Buying undervalued stocks is a value investing strategy of famous investors like Warren Buffet. 

The stock price occasionally differs from its intrinsic value due to several outside factors like unfavourable market sentiments and slowdown. Generally, if a stock is undervalued, it is a good time for the investor to buy it because he may make a profit. However, why is the stock undervalued? There could be various reasons, like a company might have failed due to fierce competition, been affected by rapid technological change, or been run by a group of inept and unethical managers. Whatever the cause, such businesses that underperform despite their low valuations eventually can become value traps. 

What Are Undervalued Stocks?

An undervalued stock meaning implies that the market price is somehow “wrong” and that the investor is either making a contrarian, subjective evaluation or has access to information that the rest of the market does not. 

Stock in a specific company may be deemed undervalued if its price is significantly lower than the industry standard. In these situations, value investors might concentrate on buying these investments to generate respectable returns for a lower initial investment.

However, value investing is not entirely foolproof. An undervalued stock may or may not go up in value; there is no assurance of either. The intrinsic value of a stock can only be estimated with some degree of accuracy and is essentially a guessing game. When someone claims that a stock is undervalued, they are saying that they think the stock is worth more than the price at which it is currently trading. However, this claim is inherently subjective and may or may not be supported by a good case based on the company’s fundamentals.

For instance, company B’s share is trading at Rs. 500 (Market Price); however, its intrinsic value is Rs 1000. It means Company B’s share is valued lower than its true value due to volatile market conditions.

How can one analyse undervalued stock?

One can analyse undervalued stock through evaluation of the company’s financial statements and other financial aspects, like profits, cash flow, management of capital, and return on assets.

Undervalued meaning in Brief

• A security or investment trading in the market for a stock price that is considered to be below its true intrinsic value is said to be undervalued. 
• A company’s anticipated future free cash flows are valued at their present value to determine its intrinsic value. 
• An undervalued stock can be assessed by looking at the financial statements of the underlying business and examining its core competencies, including cash flow, return on assets, profit generation, and capital management, to determine the stock’s intrinsic value. 
• A stock that is overvalued, on the other hand, is said to be priced in the market higher than its actual value. 
• Famous investor Warren Buffett’s value investing approach includes buying stocks when they are undervalued.

Who should invest in undervalued stock?

Investors should invest in undervalued stocks if they are looking for attractive long-term value and are willing to accept the risk that their investment might fail. The best time to buy undervalued stocks is when the price is relatively low, and the business has room to run. The key to this strategy is finding good undervalued companies that could still become big winners by making a few key improvements. 

Undervalued stocks significantly underperform in the overall market. Investors can acquire shares at a discount to intrinsic value, which means they pay less than what they would be as the actual price is low for any reason.

You should be able to value any stock if you understand its current price as a percentage of its intrinsic value, i.e., the company’s worth before interest, taxes, and other costs. If a company’s P/E ratio is trading below historical norms, it’s possibly discounting its true valuation by using low earnings (or a bad economy). This could mean that investors are paying too much for it or that the business and its industry aren’t growing enough to justify such a high price tag.

Undervalued Stocks are a simple and effective investment strategy for making money. Investing in undervalued stocks can be a great way to build wealth, increase your retirement account, or supplement your retirement plans. Investors should consider undervalued stocks as long-term investments. These types of stocks can also provide excellent returns relative to the market. If you are looking for stocks that are trading at a discount or at prices that are undervalued, then you should invest in these undervalued stocks. 

Why should anyone invest in undervalued stocks?

Investing in undervalued stocks can give you great returns on investment and help you build wealth. Investing in undervalued companies will help you diversify your portfolio, which is a must if you invest in risky assets. The main reason to invest in undervalued stocks is that they can give great growth in a short period. Many companies growing rapidly have been trading at significantly lower than their value and have become more expensive over time. Undervalued stocks are great investments as they offer better prospects with higher growth rates. As a result, investors who purchase undervalued stocks generally see their investments grow faster than the general market.

Investing in undervalued stocks is important because it means you may gain more investment capital than if you had invested in a stock that was trading at a higher price. This strategy can impact your overall portfolio and your financial situation. By choosing the right stocks to invest in, you can greatly increase your chance of making money from them and create an opportunity to retire earlier and increase the size of your portfolio. It is possible that results may be inverse since momentum investing provides better returns than value investing, such as investing in undervalued stocks, so sometimes it can be less profitable than buying stocks based on charts and performance.

How to find undervalued stocks?

Finding undervalued stocks is simple. You need only the stock’s fair value and current share price.

Under or Over Valuation = Current Share price

         Stock’s fair value 

A company’s fair value is the current value of all the cash flows that a company will earn in the future.

Let us calculate the fair value of stock first with this formula.

Fair Value Formula = Cash [1 + r (x/360)] – Dividends

Where, 

Cash = Current value of the security.

r = Prevailing interest rate charged by the broker.

x = Number of days left in the contract i.e., the futures contract expiry x number of days

Dividends = Amount of dividends that an investor receives before the expiration date.

For example, Let’s assume that ABC stock is currently trading at Rs 1,890. The broker charges 1% interest on the sale. The futures contract will expire in 30 days. The stock investor receives 3.4 dividend points. Calculate the fair value of the stock. 

Fair Value Formula = Cash [1 + r (x/360)] – Dividends

Cash = Rs 1,890 

r = 1%

x = 30 days 

Dividends = 3.4 points

Fair value formula = 1890 [1+.01(30/360)]-3.4 = Rs 1888.16

The fair value of ABC stock is Rs 1888.16

Now, let’s see how to calculate undervalued stocks. There are many ratios that can help to calculate this. We will use the P/E ratio. 

P/E Ratio = market price per share/Earnings per share

For example, Company XYZ’s stock price closed at Rs 80 and the earnings per share for the fiscal year was Rs 8. 

So, the P/E ratio = 80 / 8 = 10  

Newsletter

To search for an undervalued stock, you need to subscribe to paid newsletters that publish expert stock ideas and research. Examples like Moneycontrol, Invest tech, Economic Times and others. These newsletters provide investors with a deep analysis of stocks and meticulously researched fair value estimates. 

Tools

Apart from premium newsletters, you can also check out some tools that recommend the best stock every month, tools such as Finology, TickerTape and Moneycontrol. Combine these tools, and you will get fundamental research, i.e., “what to buy,” and technical research, i.e., “when to buy.” This information is useful for any investor looking to invest in undervalued stocks. 

Buy top 3 stocks in the undervalued sector. 

The best approach to finding undervalued stocks involves searching for undervalued sectors first and then selecting the best stocks in each undervalued sector. 

For instance, if your research suggests that the healthcare sector is undervalued. Then simply buy the top three companies’ stocks (currently Apollo Hospital, Max Healthcare, and Fortis Health)*.

Follow expert value stock investors

Another way of finding undervalued stocks is to follow the expert value stock investors. If you can find the best investment managers with a record of picking undervalued stocks, you need to follow them and analyse their buy and sell over time. 

Pros and Cons of Investing in Undervalued stocks

Pros

You need to adopt a successful value investing strategy.

• Right speculation is beneficial for any investor. If you are an experienced investor who can analyse the market correctly, then you know which is an undervalued stock and what’s the best time to buy them to accrue profits. 
• You may grab some profits in the short-term period if you invest in undervalued stocks.
• As the stock catches up to its fair price, you make money because of an increase in share price. 
• There is another benefit to the undervalued stock; since the stock is already undervalued, there is less chance that it might dip further.

Cons

Buy low, and sell high may look like easy advice, but it is tough to implement. 

• Markets are unpredictable. Even if you are right about your analysis of a stock being undervalued, it might remain so for a very long time. Therefore, it can be frustrating for an investor to wait for months or maybe years for the market to catch on. 
• Sometimes, you need to take undervalued stocks at their face value, meaning that the stock is cheap because the company’s product will fail in the future, or the government will regulate the product, or many other reasons. One needs to study all factors before investing in undervalued stocks.
• Beware of “Value Traps.” Some undervalued stocks remain permanently stuck and may never return to a fair valuation or might decline further.
• Betting that the whole market is wrong might go wrong for you. The market has decided the price of a stock, and if you believe that everyone is trading the stock wrong, you are taking a high risk. A contrarian evaluation without apt skills or knowledge can give you losses. 

List of undervalued stocks

Undervalued Stocks, USA (2022)	Undervalued Midcap Stocks, India (2022)
Berkshire Hathaway	Shyam Metaliks & Energy
Target	Manappuram Finance
Amazon	CESC
JPMorgan Chase	Mazagon Dock Shipbuilders
IBM	Motilal Oswal Financial Services

Why do stocks become undervalued?

• Negative headlines about a short-term issue can cause investors to sell stocks excessively.
• A bad reputation can negatively impact its share price. A company might have a good record of strong quarterly earnings, but even then, investors ignore them because they think the company is in trouble.
• Suppose the media reports that a company’s business practices have come under the government radar, and they might look into it in the future. In that case, it can cause the stock to decline dramatically.
• If investors ignore a company’s stock, it can also be the reason for being valued inappropriately.
• A small company is often overlooked by investors and analysts. They might not realise that its stock is trading below its fair value.
• If the company’s debt position looks risky, the investor might not buy its stocks. 
• Bad leadership, faulty decisions, and management failures can demotivate investors from investing in a company despite good future prospects. 
• Strong competition can sometimes make investors edgy. They might think that the company is in trouble. 
• Any big scam, accident, or legal trouble can decline a company’s stock prices. 

Factors affecting the undervaluation of shares

• The overall market is down cyclical behaviour
• Diversification
• Non-trendy stocks
• Herd mentality
• Low price-to-earnings ratio (P/E ratio)
• Bad press
• Net cash flow

The overall market is down.

The market suffers when a country’s macroeconomic conditions are poor, it is likely the most frequent factor leading to the undervaluation of shares. Due to such unfavourable circumstances, the market value of shares declines. To estimate the value of shares, investors should have a fundamental understanding and awareness of the overall economic conditions. The market can also crash due to investor behaviour like over-investing and herd mentality. 

Non-Trendy Stocks

Companies that lead in trending sectors tend to draw more demand for their stock and investments. In contrast, stocks of well-established firms with robust fundamentals in non-fashionable sectors can go undervalued. Investors should be well aware of different sectors and be open to diversification to make the most of valuation trading.

Diversification

Businesses that can find disruptive products and services, allocate new markets, channels, or positioning, can also have undervalued stocks. Brands may reach a fresh destination or might take advantage of a new market; still, their shares are priced at the same market value despite these innovations. However, a clever investor will quickly recognise this and buy such undervalued shares.

Herd Mentality

Investors are advised to place trades according to the market’s momentum and make decisions regarding the sale or purchase of assets accordingly. Investors queue up to buy shares when the market’s overall momentum is high, and due to the herd mentality, they line up to sell shares when it is declining. This is how shares get undervalued. Investors should therefore hold onto such shares to benefit most from valuation trading.

Cyclical Behaviour

The value of a company’s shares is determined by its profits. Sometimes, a company’s production and sales are based on its seasonal nature. Additionally, the demand for its goods and services can be seen in a cyclical pattern. Therefore, even if a company like this has solid fundamentals, its stock price will fall during a decline in sales before rising again when its profits increase. Traders who are aware of this can make wise investments.

Bad Press

The price of a company’s shares always drops when it finds itself in a circumstance that generates negative media attention. Such negative publicity is only one of the many obstacles a company must confront and overcome. Such coverage’s temporary loss of share value is not necessarily a sign that it will completely collapse. Traders must determine whether a company is resilient enough to weather a crisis after one of these occurrences. If so, they can invest in its undervalued stocks to increase future profits.

Net Cash Flow

Companies are typically viewed as good investments if they report high profits. Some investors, however, pay more attention to the company’s net cash flow. The cash flow available after outflows of capital and operating expenses are referred to as net cash flow. Even though a stock’s net cash flow is strong, its price may be low due to lower earnings. However, if the business uses this money to grow operations, its share price will rise, and it will be a good deal in the long run.

Low-debts stocks

Regardless of whether you are a valuation trader, low debt is undoubtedly a desirable quality in stocks. Value traders are often reluctant to invest in power, steel, and infrastructure companies because of their high debt loads. Companies with steady growth and low debt are profitable and generally carry undervalued stocks. Such stock prices are bound to increase in the future.

High Dividend Yield

When a company does not have any more investment opportunities left, it pays out high dividends. 

The company’s share price may decline as a result. This may concern some investors, but it may also be a sign that the company can withstand challenging market conditions thanks to the funds set aside for dividend payout. Investors can purchase this stock and start receiving dividends immediately if other factors demonstrate that the company is not in immediate financial danger. They may also sell the shares at a higher price later.

Price-to-book ratio

The ratio between price per share and the company’s book value is known as the price-to-book ratio (P/B). It is a yardstick to measure the business’s financial health and reflect on whether the company will earn profit in the future. Unless the company is experiencing a severe financial crisis, low market value compared to book value is generally considered a sign of good undervalued stocks. 

Low price-to-earnings ratio

The price-to-earnings ratio (P/E ratio) shows what the market is willing to pay today for a stock based on its future or past earnings. A high P/E ratio indicates that the stock price will be higher than its profits. And a low P/E may indicate greater profits relative to the share’s purchase price. Value investors should look for businesses with low P/E ratios to maximise their profits. 

Bottom line

Buying undervalued stocks is an investment strategy used by traders who want to make long-term investments or have the patience to wait for undervalued stocks to rise to their fair value. Even though this is not a comprehensive list and none of the above elements alone can determine whether a specific stock is undervalued, when taken as a whole, they can paint a complete picture of a company’s share valuation. Value stocks or value investing terms are thrown around casually. However, unless an investor knows about stock trading and its complexities, he might lose more money before gaining any. This article has suggested how to find undervalued stocks and discusses what is undervalued stocks in detail.