A stock or a share represents partial ownership in a company. When an investor buys stock in a company, they become a shareholder in the company with a claim on the company’s profits and assets in proportion to the percentage of stocks owned by them. As the company’s profits increase and assets grow, the value of the stock also increases.
In the Indian context, stocks are traded electronically on the stock exchanges through stockbroking platforms and stored in Demat accounts. Stocks are generally traded on the two prominent stock exchanges, namely the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Stock markets in India are regulated by the Securities and Exchange Board of India (SEBI), which ensures proper functioning and investor protection.
Investors buy and sell stocks for several reasons, including the potential for capital appreciation over time, to take advantage of short-time price volatility, and for dividend income. Equity or stock investments are considered to be high-risk, high-reward investments that make up a major chunk of the investment portfolio for most investors.
How stocks represent ownership in a company
When you own stock in a company, you are called a shareholder or stockholder and are eligible to claim part of the company's assets and earnings should the company ever dissolve. The terms "stock," "shares," and "equity" are used interchangeably in modern financial language.
When a company needs to raise capital or funds, it may decide to either borrow from a financial institution, issue corporate bonds or issue equity shares through an Initial Public Offering (IPO). Investors can bid for the IPO and later trade these shares on stock exchanges like NSE and BSE.
When a company grows and its profitability increases, the stock price may also witness an upward trend, thus increasing the value of the shareholders’ investments. Conversely, if the business does not perform well or is negatively affected by market sentiments or economic conditions, the stock price may see a decline.
Some of the most important factors that affect a business’ profitability are global and local economic conditions, the sector’s performance, changing governmental policies and regulations, and natural disasters, among others. However, if market sentiments regarding the company remain positive, the stock may still see upward momentum.
Types of stocks
Stocks can be categorised in several ways based on their characteristics, market capitalisation, and the rights they confer to the shareholders.
This is the most prevalent type of stock that retail investors purchase. Common stock represents ownership in a company and grants voting rights to shareholders regarding major corporate decisions. Dividends are not guaranteed for common stockholders and may vary based on the company's profitability. If the company undergoes liquidation, common shareholders have rights to a company's assets only after the company’s debtors (bondholders) and preferential shareholders have been paid.
Preferential stockholders get priority over common stockholders when it comes to dividends and in case of liquidation of the company, but they generally do not have voting rights. Preference shares may or may not be convertible into common stocks, depending on the type of preference shares that were issued to the investors.
Based on market capitalisation, common stocks may be further divided into the following categories.
The stocks of well-established, financially stable companies with a long history of reliable performance are generally considered blue-chip stocks. These stocks have lower volatility than mid-cap or small-cap stocks.
Stocks of companies with a large market capitalisation are referred to as large-cap stocks and are considered to be more stable than their mid-cap and small-cap counterparts.
Stocks of companies with a medium market capitalisation are called mid-cap stocks. They are generally more volatile than large-cap stocks.
Stocks of companies with a small market capitalisation and higher volatility are called small-cap stocks.
Some other categories of stocks include:
Stocks whose trading price is very low, generally in single digits, are highly volatile but have low liquidity and are considered to be penny stocks. The low price makes it easier to buy huge quantities of these stocks, but the lack of liquidity makes them a relatively risky investment.
Stocks of companies that hold a record of sharing their profits with investors by paying dividends regularly are called dividend stocks. Investors buy these stocks with an intention to receive regular dividend income rather than for capital appreciation.
Importance of Stocks in Financial Markets
Stocks play an important role in the Indian financial markets and the broader economy.
The biggest reason that investors park their funds in stocks is because of the potential for higher returns even as risk remains high. If the company is profitable, the share price will increase and thus increase the value of the investor’s capital. Stocks have generally given better returns in the long run as compared to most other asset classes.
Investors may seek out dividend-paying stocks as a source of regular income. Companies that frequently dole out a portion of their profits and share it with their shareholders are sought after by such investors.
Investing in stocks helps in diversifying the investment portfolio and ensuring that a downturn in one sector will not put a huge dent in total capital. Smart investors tend to buy stocks of companies operating across different sectors.
Investors holding common stocks of the company may be able to vote for major company decisions and influence the progress of the company. However, this is only effective if a majority of the shareholders vote for the same decision.
Conclusion
Understanding the basic concept of stocks is essential for investors who want to participate in financial markets in India. Investing in stocks offers significant potential for capital appreciation, but it is also important to understand the risks involved.
Whether you're looking to capture short-term volatility, seeking long-term growth, or want regular income through dividends or a combination of all three, stocks can be a valuable addition to your investment portfolio. Remember to keep your investment goals as well as risk tolerance in mind when evaluating which stocks to invest in.
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Small-cap stocks