A stock/share of a company is a security that gives you as a shareholder an ownership in the company. You have the right to make a claim on the assets and earnings of the company in proportion of the stake that you hold in the company.

Broadly shares can be grouped under two categories:

• Common stock: Common stock represents your ownership in the company to the extent of the number of shares held as a proportion of the total shares issued. For instance, if you hold 1000 shares out of the total 1 lakh shares issued by a company, then you have a 1 per cent stake in the company. Common stock is also referred to as equity shares.
  
  As an equity shareholder, you are entitled to voting rights in the company, which are generally in proportion of your shareholding in the company. You also enjoy the right to dividend, if declared by the board of directors of the company. However, in case of liquidation, you have the last claim over the company assets i.e. only after the debtors, bond holders and preference share holders are paid in full, do you receive your dues.
• Preferred stock: Holders of preference shares get a fixed dividend every year. It is mandatory for the company to pay dividend to the preference share holders before it pays dividend to the equity share holders. Although preference share holders are partial owners of the company, they do not enjoy voting rights in the company. In case of liquidation of the company, preference share holder’s claim on the residual assets of the company supersedes that of equity share holders.

Common stocks can be classified on the basis of their market capitalisation. Market capitalisation represents the value of the total shares issued by the company. It is calculated by taking the product of the total number of shares issued by a company and the latest market price of the shares of the same company on the stock exchange. Stocks can be classified on the basis of market capitalisation as following:

• Micro caps: Stocks of companies with market capitalisation of less than Rs. 50 crore can be termed as a micro cap stocks.
• Small caps: Stocks of companies with market capitalisation between Rs. 50 and Rs. 500 crore can be termed as a small cap stocks.
• Mid caps: Stocks of companies with a market capitalisation between Rs. 500 and Rs. 5,000 crore can be termed as mid cap stocks.
• Large caps: Stocks with a market capitalisation between Rs. 5000 crore and Rs. 25000 can be classified as large cap stocks.
• Ultra large caps: Stocks of companies with a market capitalisation of more than Rs. 25000 crore can be classified as ultra large cap stocks

Generally, large caps would be existing industry leaders and mid-caps enjoy the possibility of becoming future leaders who have just begun the growth curve.

Though equities as an asset class command a high investment risk vis-à-vis other investments such as debt, bullion, real estate, etc., they have various advantages attached to them:

• High returns net of inflation and tax
• Historically, best performing asset class over long term
• Ideal for wealth creation and fulfilment of financial goals

Thus, investing a part of your savings in equities for the long term makes ample sense, especially for young investors.

There are various risks that accompany equity investments. You need to understand these before making the investments.

• Market or economy risks: The returns from equities depend on the earnings of the company. Generally companies perform well when the economic conditions are favourable. The profits of companies tend to rise in a thriving economy and vice versa. Thus equities generally under-perform during an economic downturn when compared to other asset classes. However over a longer period which may consist of several boom and bust cycles, equities generally have an edge over other asset classes.
• Industry risk: Sometimes a company may not perform well even in a favourable economic environment if the conditions for the sector in which the company exists are unfavourable. An aggressive capacity addition in a particular sector or some government policy may affect the prospects of an industry as a whole. Such a situation may affect the various companies operating in the sector and all the companies may underperform for some time.
• Management risk: Management of a company is not an easy task. One of the striking features of most joint stock companies is separate management and ownership. Good management can transform a sick company in a viable one and vice versa. Thus it is extremely important to invest in companies with a good management track record. This risk associated with management of a company is nothing but management risk.
• Business risk: Any risk associated with a business is termed as business risk. These include risks such as fire, theft, obsolescence of technology, non availability of raw material, strikes by labour force, accidents at work place etc. come along with any business.
• Financial risk: Companies often resort to borrowed capital to fulfil their growth plans. However to raise funds from debt, the company has to mortgage their assets in favour of the lender. If the company is unable to generate expected cash flows from their new projects and is unable to repay the interest or principle, the lenders may approach the court of law and take charge of the assets mortgaged.
• Exchange-rate risk: With globalisation, most of the companies have some interest in overseas markets. Either they may procure raw material, machinery, technology etc. from overseas or may export their products, services etc. to customers or clients overseas. In foreign transactions, there is an inherent risk pertaining to exchange rates as these fluctuate on a regular basis. The risk arising due to the fluctuating rates of currency is called exchange-rate risk.
• Inflation Risk: The rise in existing price level leading to a higher cost of living can be termed as inflation. Due to inflation, fixed costs such as salaries and wages, rent, utility bills etc. and variable costs such as raw material prices, cost of power, etc. may rise. Selling price may not always increase in line with the input costs and the fixed cost. This may squeeze the profit margins for companies and may result in companies operating at a loss till the situation improves.

Beta is a statistical measure of the risk involved in an investment. It measures the volatility of a stock in relation to the overall market.

Thus stocks with higher beta are more volatile and thus more risky than stocks with lower beta.

With more than 9000 on NSE and BSE, it becomes difficult to choose a few that can comprise your portfolio. To arrive at this chosen few, you can adopt various investment methodologies such as:

• Top down approach and bottom up approach: In a top down approach the macro factors such as the whole economy are studied first. If the macro factors are favourable then various industries which will benefit are identified. Then, companies from the sector which are poised to take advantage of the favourable situation are short listed. These companies are then compared among themselves on various yard sticks of valuations and growth potential and the most favourable is chosen for investment.
  
  On the other hand in case of bottom up approach, companies with low valuations are first identified. Then, the sector to which they belong to is analysed and finally the macro economic factors are studied. Thus, at any point during the analysis, if the analyst feels that conditions are unfavourable for the company the stock is discarded from the list. This helps to shortlist a few companies from the long list of companies analysed.
• Using Price to Earnings (P/E) as a yardstick: P/E ratio is one of the widely accepted tools to value companies. P/E ratio is calculated by dividing the latest market price of a company with the earnings per share reported by the company for the last four trailing quarters. This ratio denotes the payback period if invested at the current market price through earnings.
  
  To illustrate, suppose XYZ Ltd. is available at a price of Rs.100 at present and the company has reported an earnings of Rs.20 in the last four quarters. The P/E ratio for the stock would be 100/20 which is equivalent to 5. This means that if one invests in the company at current levels and the company maintains the earnings of Rs.20 per year it would take 5 years to get back the original investment amount through the earnings route. Generally, lower the P/E ratio higher the value of the company and vice versa. However as a thumb rule, P/E of one company cannot be compared with another if both of them belong to different sectors or industries. Ideally P/E ratios should be compared with industry average P/E or with companies with a similar business.
• Discounted Cash Flow (DCF) analysis: In DCF analysis, the cash flow generated by a business is considered and not the earnings after tax. The various projected cash flows are discounted by a discounting factor in order to arrive at a value. The discounting factor is generally the cost of capital and may be different for each investor, depending upon his/her expectations from the investments. If the total value of the discounted cash flows is greater than the present market value of the stock then the stock qualifies for investment. The lower the market price as compared to the total discounted cash flows the more is the scope for appreciation in the future and vice versa.
• Economic Value Added (EVA): EVA is the profit earned by the firm less the cost of financing the firm's capital. It implies that shareholders of the company will receive a positive value added when the return from the capital employed in the business operations is greater than the cost of that capital.

Timely reviewing of your portfolio is very important to ensure that your investments are in-line with the changing economic and business scenario. Following are the various ways to assess your investments:

• Assess companies' quarterly performances: As per the guidelines of the stock exchanges and SEBI, all listed companies have to publish their quarterly results. These quarterly results are available on the websites of the respective exchanges. The quarterly results if studied properly, give an idea about the operations of the company. You can decide whether to buy, hold or sell your holding after reviewing the quarterly results.
• Study overall trends in capital markets and the economy: Along with the performance of the company, you should also keep a close watch on the overall economic scenario and sentiments in the market. Stocks may underperform if the overall economic conditions are unfavourable or the market mood is negative.

Selling at the right time is a hallmark of a successful investor. You should never let emotions drive your investment decisions since it may have a negative impact. You can consider selling in case:

• The stock is over-valued: Valuations often drive the price of stocks in the stock markets. These valuations may be impacted by the industry PE ratio, book value, etc. Stock prices tend to touch extreme highs and lows due to market sentiments. Such extreme levels on the upper side should be used as opportunities to sell the stock which can be bought when valuations come to lower or normal levels.
• The company is in the news for all the wrong reasons: Many times stock prices are driven by news in the markets. News which has a negative effect on the company’s earnings, such as related to its management, business dealings, etc. should be closely watched and one should exit if such news comes out in the market. However, check the authenticity of the news as markets are sometimes misled by rumours.
• You need to rebalance your portfolio: Rebalancing the portfolio due to age, risk taking capacity, or any other reason may prompt you to sell the shares.
• Peer companies are performing better: If another company with similar business and valuation is performing better, then you can sell in order to shift the investment in the better performing company.

Over and above the share price appreciation and dividend income, as an equity holder you can also earn in the form of:

• Bonus shares: These are shares which you receive from the company at no cost. The number of shares that you receive is based on the number that you hold. To be eligible for the bonus shares, you need to hold onto the shares as on a particular date (which is announced by the company). The proportion of bonus shares may differ from case to case. The market rate of shares on the ex-bonus date may fall in proportion of the bonus shares issued, since after bonus, the equity base of the company is enhanced and the earnings of the company would be diluted on account of a larger share equity base. For instance, if a company declares a bonus for each share held, then on the ex-bonus date the share price would approximately fall by 50 per cent.
• Rights: Whenever a company needs funds for expansion or for any other purpose like working capital, repaying high cost debt, etc. then it may come out with a rights issue for its existing share holders. In case of a rights issue, if you desire, you can purchase additional shares at a considerable discount to the market price. The market price of the share generally falls between the rights issue price and the previous market price as the equity base in case of rights issue too increases.
• Splits: A company may split the face value of its shares in order to make it more affordable for retail investors or to increase the volumes of shares traded on the stock exchange. In such a case the face value of the shares reduces and the market price too drops in the proportion of the face value. For instance, if the face value of the share is reduced to Rs 2 from Rs 10 then the market price will drop to approximately one fifth of the original value. When shares are split, the original shares are divided into a number of shares of a lower face value. i.e. 5 shares of Rs. 2 in the example considered above.
• Buy-backs: A company may wish to buy back additional shares in the market in order to increase the value of existing or to avoid threats posed by investors looking to win a controlling stake in the company.

• STT: STT or securities transaction tax is a turnover tax applicable on sale and purchase of securities. This tax is levied on the total value of trades irrespective of the profit or loss incurred by an investor. The present rate of STT for in case of delivery trades is 0.125% of the trade value.
• Capital gains: Any gains from trading in the stock markets is classified into two categories viz. short term gains or losses or long term gains or losses. If a security is held for 365 days or more, then any kind of gain or loss in that particular stock is called as long term capital gain or loss. Similarly if any security is held for less than 365 days then any gain or loss arising from that security is classified into short term capital gain or loss. At present the rate of tax on short term capital gains is 15 per cent (plus 3 per cent cess) while there is no tax on long term capital gains. Short term capital losses can be set off against short term capital gains. Long term capital gains are presently, tax free.
• Section 80C benefit in case of investing in IPOs of certain specified infrastructure companies.

Note: All tax laws are as per the Financial Year 2010-11

In order to compute the returns on your equity, you need to consider a few factors. These are indicated below.

5 Golden Rules On Equity Investing

• Buy at a correction and sell in a rally: The most basic rule of trading in equity is buy low and sell high. Thus an investor should ideally enter into the markets during a correction and sell the shares while the markets are rallying.
• Don't buy all at once: You should not invest the entire investible amount in the market at one go. Rather, follow a disciplined habit of regular investing. Once some portion of the total amount is invested you should wait for some correction to make a further entry into the markets. This will bring down the average cost of acquisition.
• Diversify to control risk: Diversification reduces the risk associated with equities to a certain extent. You should invest in various companies across various sectors of different market capitalizations. Thus, even if one stock does not perform well, the other may make up for the loss or under performance.
• Let your profits run and cut your losses quickly: Rather than liquidating high performing investments, it is advisable to sell the shares wherein you are incurring a loss.
• Invest on fundamentals, rather than on tips and 'friendly advice': Share price movement is susceptible to market news and rumours. Taking decisions based on these news and rumours without studying the actual effect may adversely impact your investments in the long run. Thus, you should invest on the basis of the fundamentals of the company rather than on tips from friends and relatives. Advice of qualified financial consultant should be taken before taking any major decision.