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Why invest and how to make money?

If you’re here to know exactly how to make money in the stock market, I’d say leave right now because I’m pretty sure you’re gonna be disappointed. Simply because there is no exact formula or shortcut to make money in the stock market. Of course there are some basic simple tricks and guidelines that work. In this post I’ll be talking about why investing is a good idea and just a little about these tricks and guidelines.

Why invest in the stock market?

Would you rather spend your money on cheap goods, stash or save money or GROW your money?

Most of you would say grow your money for obvious reasons. Some would also say stash it under a mattress. Of course, short term it sounds like a good idea because it is for sure better than spending it on unwanted things. However, the value of money keeps reducing with time i.e. how much of an item you can buy for a given amount of money keeps on decreasing as time goes on. This phenomenon is known as inflation. The main reasons are increase in money supply and change in exchange rates. There are some other reasons which are outside the scope of this blog and will come later because you need the understanding of some other concepts. Money supply is the increase in cash printing by the government. If the value of money keeps reducing why would you save it. Wouldn’t you rather grow at a rate higher than or equal to the rate of inflation. Ever since 2000 until 2020, the average interest rate for putting your money in the bank is around 6.49%. The average inflation rate is also around 6.6%. So, if you put some money in the RBI bank in 2000, the face value of the money would have grown but the value of the money i.e. what it can buy remains the same or maybe becomes a little lesser value.

I’d like to restate how money is primarily made in the market: buying company stocks at bargain prices and selling them once the stock price has grown. 

One place where the above can be done is in the stock market.

Basics concepts of investing.

The first method: Know that the prices of all companies fluctuate wildly throughout the year. Imagine being in a partnership with a person called Mr. Market. Mr. Market has severe mood swings. Each day he offers to sell or buy a stock of his business for a given price. If Mr. Market happens to be in a very good mood, he will offer you a price which is much higher than the actual value of the business, and that’s when you sell shares. However, if he is in a bad mood, he will offer a lower price than the actual value  of the business, and that’s when you buy. If the price offered by him is not relatively high or low, you could choose to not buy or sell respectively. There are many ways to see whether the given price of a stock is high or low comparatively e.g. p/b, p/e etc. These ratios will be introduced in the coming posts. Let’s take an example, let’s say the price of a company called “ranch” is 50$, after analyzing the company and market you would find that the actual value of the company is 90$. Thus, the current price of the company is very cheap compared to 90$. You would buy shares believing the price is going to go up and vice-versa if the analyzed price is lower than the actual price you wouldn’t buy it because it’s too expensive.

The next concept is having a safety margin before buying shares of a company. When you identify a company that is cheap compared to its actual value, you compare the actual price to the estimated price, and have a safety margin of a given percentage or buying/investing is not an option. For example, let’s use ranch itself, if the actual price is 100$, and you have a safety margin of 10% you would invest only if the estimated value of the company is 110$.

Thus, always keeping you from losing a large value of your money even if the company does not change price according to your assumptions. 

Some of you are already thinking, what good am I compared to those who spend 7-8 hours everyday trying to figure out how the prices will change. Well, they’re obviously better than you but remember there are more people in the market that invest based on the face value without knowing these concepts. Stick around if you wanna know more. It’d be nice if you could put your e-mail down there so you’d get updated everytime a new post comes up. Thank you!!!

How and Why Market Prices Change?

Money is made in the stock market mainly when you buy at a low price and sell at a very high price. Thus, the changes in value is your money made. Of course, there are other ways to make money in the stock market like dividends. But mainly here, I’ll be talking about the money made due to growth or changes in valuation.

Why do the stock prices change?

Before we go into how money is made, we’ve to know the reason the prices of these companies change. The simple answer is supply and demand or how much the investors think the company is worth i.e. if more people think the company is going to grow and want to buy more stock, the price will increase and vice-versa. Before I go forward I just want to make clear what a dividend is. A dividend is the part of the profits the company decides to share with the investors as a gift for investing in their company. Not all companies give dividends, some decide to invest these profits back into the company.

It is also wrong to equate the company’s value to the stock price. The total value of the company is the stock price of the company multiplied by the number of shares that are issued. A company has a given number of shares issued. These values are what the investors think the company will come upto in the future. Earnings are what the company makes as profits. And one of the main changes in sentiment of investors is caused by earnings. If the earnings are not as high as expected the price will fall and vice-versa. However this is not the only reason for change in sentiment. During the dot-com boom, many companies grew to billions of dollars just without any profits. To be straightforward, why prices change, nobody knows. Everybody just tries to make a very educated guess on how it’ll change in the future.

Some very important ideas from above:

  • Market capitalization = number of shares issued x current price of the share price. No point in comparing the prices of 2 companies.
  • Fundamentally, supply and demand causes change in price
  • Many ways to explain change in stock price no specific way to predict the movements perfectly everytime.

What is the stock market?

The New York Stock Exchange

The reason I’m putting this post out is because the last time I had posted on this platform, many of my friends reached out to me and told me to start from the beginning and explain the most basic terms. The posts will be under each other so please scroll down for the next post.

Let’s start with the basic component of the market – a share/stock

A share/stock is an ownership claim of part of the company  (usually a very small percentage). Hence, entitling you to a part ownership of their assets and earnings. A stock usually has a stock certificate which is proof of ownership. We don’t actually see these documents nowadays because they are handled online which makes stock easier to trade. Earlier, people actually had to take their stock certificates to the broker and had it traded.

The ownership of a stock does not give you a right to go and tell the top brass of that company how to function. If you as a shareholder believe that the management is not doing well, shareholders can vote them out of the company. Of course, only the larger shareholders would be able to make such big decisions since you need to own a large percentage of the company to actually have some influence. I’m going to repeat: the most important characteristic of a stock is that it gives you a claim on its assets and earnings. Another important property is a stock’s limited liability. You cannot personally lose more than your investment value if the company is in debt i.e. Owners are the shareholders. They do not hold shareholders accountable.

Next important term is Debt vs. Equity

Why would companies take loans or sell ownership of their company? Because at some point in a company’s journey, it might need money to finance its expansions. Now, there are 2 ways to finance a company:

  1. Debt financing includes taking loans and issuing bonds.
  2. Equity financing includes selling their company as stocks/shares.

Issuing bonds – Investor gives money to the company on the condition that he is paid periodic interest payments and when the bond matures, the company has to return the borrowed amount.

A very, very important rule to remember on risks of investment –  greater the risk, higher the returns

E.g. People put money in their bank accounts because it is safe, but the returns on this are very low. Usually new banks will offer higher interest rates because of higher risk. I.e. the chances of a new bank falling apart is less than an old established bank.

Different types of stocks:

Common Stock – this type of stock is the one we just discussed about which has all basic properties and has variable dividend amounts. Thus, increasing the risk and if the company fails, the common shareholder does not receive any profits.

Preferred Stock – this type of stock has a fixed dividend and does not change over time. It has much lesser risk because of the fact that the preferred stockholders are paid before the common stockholders . Common shareholders are paid last. But Stocks can be classified in many other ways also. For example, a company can make shares that have different votes per share.

So, going to the main topic of this post. What is a stock market?

It is the place where Stocks/shares of different types are traded i.e.different buyers and sellers meet and decide on a price to buy/sell that particular stock. 

On this blog I’ll be writing only about the USA and Indian markets.

US markets – 

  1. New York Stock Exchange (NYSE)
  2. NASDAQ

Indian markets – 

  1. Bombay Stock Exchange
  2. National Stock Exchange
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