Investing for beginners – Basicofinvesting

What is meant by bonus share in Share Market?

Meaning:

The Bonus shares refers to the distribution of company’s reserves to the equity shareholders by giving them ‘extra’ shares on the basis of their previously held shares. Thus giving bonus shares is a sign of positive financial status of a company.

Advantage to the retail investor:

Increase in the wealth of the retail investor:

Before we go to this part, let me tell you a different story. ‘Two halves are more than one full’.

You and your friend go to a restaurant. You both decide to order ‘one’ lip smacking tomato soup. But then you decide to place an order for ‘two’ half tomato soups instead of ‘one’ full tomato soup. More often than not the quantity of two halves combined will be more than one full. This same psychological thing happens when a company declares bonus.

Say a company has a share price of Rs.1000. It decides to give bonus shares in the ratio of 1:1. Thus a member with 100 shares will now have 200 shares. Logically speaking the share price must reduce to half at Rs.500. However, the psychological thing comes into play. Thus, the stock price is adjusted to a little more than Rs.500. Not just this, there will be more volume as the shares are trading at lesser price. Hence, the shareholders would be rewarded.

Tax planning:

Before we go into the details, there are few basics which everyone needs to know:

If the shares are held for more than one year, the gain arising shall be long term. Otherwise, it shall be considered as short term.
In case of long term capital gain on sale of shares on a recognized stock exchange where STT (Securities Transaction Tax) is paid, the gain shall be exempt to the extent of Rs.1 lakh per annum.
However, if the gain in the above case is short term, then tax shall be levied at 10% of the gain.
Shares are taxed on FIFO (First In First Out) basis. Simply speaking, the shares bought first shall be adjusted first while selling.

Consider this example,

Here, the investor originally had 100 shares on 1.1.18 bought at Rs.150 a piece. As the company announced bonus shares, the total shares doubled to 200.

Now, whenever a company announces bonus, the investor must sell half of the shares the next day the bonus is allotted. Selling them early would result into short term loss. The remaining half shares must be held for more than one year. This will make the gain as long term.

In the table above, the investor did the same. He sold only 100 shares on 1.6.18 at Rs.75. The buying price on 1.1.18 was Rs.150. When the company announced bonus the shares doubled but the share price was reduced to half.

Now, as per FIFO, the 100 shares sold on 1.6.18 at Rs.75 will be assumed to be the shares bought first on 1.1.18 at Rs.150. This will result into short term capital loss of Rs.75 per share. Therefore, the total short term loss shall be Rs.7500. This loss can be adjusted against other short term capital gain and one can reduce the short term capital gain tax liability which otherwise would have been taxed at 10%. The remaining 100 shares must be sold after 1 year to turn them into long term and this will now help one in claiming exemption of Rs.1 lakh.

What is market Capitalization (Market Cap) in shares?

Market capitalization is nothing but the total number of outstanding shares of a company multiplied by the market price per share.
Sounds quite easy, doesn’t it? But there is more to the concept of market capitalization than just the above basic definition.

Market capitalization of a stock shows the size of the company and most of the times, the volatility of a stock depends on its market capitalization.

Let me put this in a different way.

So we have three images. Image A- a bike, Image B- a car and Image C- a truck. If I ask you a simple question as to which of these is easy to push in case these vehicles are stuck, the answer would be the bike, then the car and the most difficult to push would be the truck.

You see this is very much comparable to the market capitalization of the stocks.

Image A depicts stocks with smaller capitalization. Image B depicts stocks with medium capitalization and Image C represents the stocks with large capitalization. The people pushing these vehicles are the investors. The more they push the more the vehicle move ahead. If they stop pushing it, the vehicle would move back.

CASE A- Pushing the bike

A bike requires one or two people to push and can be very easily pushed. So is the case with small cap stocks. A lot lesser number of investors can lift the stock up or bring it down.These small cap stocks show great movement both upwards and downwards. Hence, they tend to be more volatile. For the same reason when such small cap stocks are performing really well, they can turn out to be potential multibagger. But then again, these are high beta stocks and they are riskier than the blue chip large cap stocks.

CASE B- Pushing the car

A car requires more people than a bike to push it. Hence again this is comparable to mid cap stocks. These too tend to be more volatile than the large cap stocks. But they tend to give fancier returns than the large cap stocks.

CASE C- Pushing the truck

A truck requires many people to push it. The behavior of large cap stocks is akin to this. The large cap stocks require lot of investors showing great deal of interest in them for it to show a big move both ways. So, even if few investors sell the stock, the stock won’t fall much. The same is true the other way round as well. The stock won’t go up a lot if few investors buy it. Hence, these stocks are less riskier than the small and mid cap stocks. People who hate the volatility in the stock market and are having conservative approach of investing their money generally invest in large cap stocks. They tend to be safer bet as compared to the small or mid cap stocks.

How to see Market cap of a stock ?

The highlighted part shows the market cap

What is difference between bonus issue and split in shares

Before we understand these two concepts, let me explain you these two terms:

Face Value: It is nothing but the nominal value of the share so fixed by the company in the beginning. It is the value at which the company registers itself initially. It won’t change daily with the market forces.
Market Price: It is the price at which the share is trading in the stock exchange. It is always fluctuating depending on buyer(s) and seller(s).

The Market Price of Infosys ltd. is around Rs.1400 whereas its Face Value is only Rs.5.

Okay, another small basic economic concept which one must know.

More the supply, lesser would be the Market Price. Less the supply, more would be the Market Price.

Stock Split

Say, you have a rectangular piece of chocolate. It was worth Rs.10. You decide to cut this into two equal parts. So now, you have two pieces of chocolate each worth Rs.5.

This is what happens in case of a Stock Split. The company going for a stock split will reduce its ‘Face Value’ and the number of shares would increase proportionately.

Say, a company has issued 1 lakh shares of Face Value Rs.10 and the Market Price is Rs.500.

If the company is going for stock split and say the Face Value is reduced to Rs.5, then the total shares would increase to 2 lakh. Also, the Market Price would be adjusted as the supply of the share has now doubled.

That’s all about the stock split.

Bonus

Bonus is something completely different from Split.

Say, I have 1 chocolate and now I am getting 1 free on this chocolate, so now I have 2 chocolates. This is how Bonus shares work.

Say, a company has issued 1 lakh shares of Face Value Rs.10 and the Market Price is Rs.500.

Now, if the company declares Bonus of 1:1, then every shareholder will get 1 extra share for 1 share held. This would double the number of shares. Here, the Face Value shall not change. It is intact at Rs.10.

If you remember the above concept, you will now know that the supply of share has doubled and hence the Market Price will also proportionately get adjusted to half.

What difference will it make to a shareholder?

The total market valuation of all the shares in totality held by the shareholder in case of Stock Split and Bonus will remain the same as before and technically it actually won’t make much of a difference to a shareholder.

But, in case of Bonus Share, you have extra shares with the same Face Value and when a company declares dividend, it is always declared on Face Value. Hence, a Shareholder will get double dividend as compared to the one in case of a Stock Split.

Hence, for a shareholder’s point of view, Bonus is more rewarding than a Stock Split.

What is support and resistance in share Market?

UNDERSTANDING RESISTANCE

Say, you are driving a car. You start the engine and put the car in first gear. The car runs smoothly till the speed reaches 20 km/hr. No much harder you try, the car speed won’t increase unless you change the gear.

Now, you change the gear and the car is in the second gear. Due to this, the speed limit has increased to say 30 km/hr. And if now you want to increase the speed further, you need to shift the gear to the higher side.

This is what happens to a stock in stock market. A stock which is moving up, will go up till it reaches a level where it has exhausted. This is called as ‘Resistance Level’. When we say that a stock price is showing resistance, it means that the stock has shown signs that it will not go up further. At resistance, one needs to sell the stock because it has little room left to run further.

However, when a stock crosses resistance, it means that it has entered into a new zone. Hence, there will be more chance of it moving further up. This is akin to the car shifting the gear to a higher number and hence the car can increase the speed till the limit is exhausted.

Whenever a stock reaches its 52 weeks high (which means the highest price in past one year), there will be more chance of it moving further up if it enters a new zone and an uncharted territory. Hence, one must buy when this happens. As the stock has got new legs to run.

2] UNDERSTANDING SUPPORT:

Say, you are driving a car uphill. Now, the car is moving slowly and steadily upwards. However, unfortunately your car runs out of fuel. Now, will you leave the car as it is and let it go down the hill with great speed or apply breaks and stop it midway?

Well, if you choose the later, then the car will stop at someplace and we can say that the hand break supported the car from falling further.

The same happens in a stock market. When a stock has fallen a lot, people who feel that the price is too low to fall further, start to buy the stock. This means that the stock price won’t fall at a certain limit. And this price level is called as ‘Support Level’.

One must buy at ‘Support Level’. This is because at this level there is more upside and less downside. Having said this, there are other associated risks too. Say, if a stock breaks it support level, this would mean that it has more room left for further downside. Hence, it will fall further, till it reaches a new ‘Support Level’.

Hence, they say, whenever a stock is at its 52 weeks low, investors must be cautious. Because, if it breaches the support level, then there will be more scope for it to fall further. So, buying a falling stock in hope of it finding the support is similar to catching a falling knife. The risk reward is high!

3] UNDERSTANDING CONSOLIDATION:

It is scary when a stock moves up or down fast in a short span of time. Hence, they say that for a stock it is very important to consolidate. Basically, ‘Consolidation’ means a stock is spending too much time in a particular zone. Hence, if the upper limit is crossed, we say that after spending too much time, the stock has now entered a new zone which will take it up further. Same is true for its downside.

A prudent person may think of buying cheap and selling at high price. But, when we study the technical terms like ‘Support’ and ‘Resistance’, we realize that when a stock crosses ‘Resistance’ it must not be sold even if the price is higher. As, it can move up further.

And when a stock breaches ‘Support’ it must not be bought even if the price is lower. As, it can go down further. In a way, we can say that there is little application of ‘Law of Demand’ in short run in stock market