Following are some of the important considerations before investing in the stock market:
Stock Investment Guidelines:
Stock Investment Guidelines:
- DIVERSIFY YOUR INVESTMENT: The best way to minimise risk is to diversify your investments across various investment products. If equities are your sole investments, it makes sense to diversify between different sectors and companies. In this way, loss incurred on some investments can be absorbed or compensated by gains made in others.
- UNDERSTAND YOUR RISK PROFILE: As an investor, you must choose between how much risk you can take as all investments carry a certain amount of risk. Consider an investment product not only according to your requirements and how much capital you can invest, but also according to your tolerance of risk. Depending on how ‘risk averse’ or ‘risk-prone’ an investor you are, you may choose an investment accordingly.
- DO YOUR HOMEWORK BEFORE YOU INVEST: To invest well, you must gather and understand all relevant information regarding the investment you are going to make. This includes studying companies’ annual reports, accounts and other statements while keeping abreast of what is happening in the said sector or industry. Consult your investment adviser/ stockbroker to get the latest market information about shares you wish to buy or sell. Do not buy into rumours or be pressured by anyone’s grave but unfounded recommendations before making an investment decision.
- THINK LONG TERM: Investment in shares does not necessarily result in instant yields. Do not invest any money which you may need immediately, since the price of shares can go up and down. Studies have shown that investments properly timed and based on strong fundamentals have been proved to be very profitable for investors in the longer term.
- JUDGEMENT OF TIMING: The aim of investing in stocks and shares is to buy at low and sell at high. Knowing when, however, is the challenge. While it is not easy to time the market, investors should try their best to buy when the upswing has begun, and sell as the downswing starts.
- AVOID HERD MENTALITY: The stock market is driven by two emotions: greed & fear. People are usually caught up in the boom hype and pay beyond the worth of shares. This is the greed that drives bull markets. Don’t allow greed to become your need. In bear markets, people get carried away with the ruling pessimism and are eager to sell their investments believing in the worst rumours. This is the fear that dominates bear markets.
- BEWARE OF SCAMS: Beware of promises of quick profits or sky high returns. Investors must bear in mind that higher the gain on investments, higher is the risk involved. This is the fundamental risk/ reward trade-off.
- KEEP AN EYE ON STOCKS’ PERFORMANCE: Investors must keep an eye on the performance of stocks. They can do so through newspapers, digital media, investment magazines, brokerage firms’ research articles or through other media. A company’s stock performance can take a boost or downturn based on some fundamental changes in the company such as a structural or financial reform. Similiarly, a company can face seasonal or circumstantial boom resulting in better stock performance.
- TAXES & COMMISSIONS: As an investor, you must know the rates of taxes and commissions charged by the Federal Board of Revenue/ Brokerage firm as these affect your costs and hence your returns. There is no prescribed rate of commissions charged and it can vary from firm to firm. Investors must take into consideration the taxes that will be deducted from the trading transactions they will undertake. (For details on current taxes and charges levy, contact your brokerage firm).
- DIVIDEND & DIVIDEND YIELD: An investor may invest in stocks of a company for its Dividends.
Dividend is the return paid to shareholders out of the profits of the company. Dividend can be cash dividend or bonus dividend/ shares. Dividends may be paid out by a company more than once a year.
Cash dividend provides for a measure called Dividend Yield. Yield is the measure of cash flow that an investor gets on the amount invested in a security. Dividend Yield is a financial ratio that indicates how much cash dividend a company pays in terms of its share price. Dividend yield is calculated by dividing the cash value of the dividend by the share price. It is defined in percentage.
- EARNING PER SHARE (EPS): This is a ratio calculated by dividing a company’s net profit after tax by the number of shares outstanding. It’s a measure of the strength of the company in terms of its earning capability for each share issued.
- PRICE EARNING RATIO (P/E): This is a ratio calculated by dividing the current share price by its EPS. It’s a measure of valuation and indicates whether the price of a share is realistic and is in-line with its earning. If the share is over-priced, then the ratio will be high and if the share-price is low, the ratio will be low.
- BOOK VALUE OR BREAK-UP VALUE: Book Value per share is calculated by dividing the total equity of a company by its number of shares outstanding. This ratio indicates the asset coverage that each equity share represents in the company.
- CAPITAL GAIN: Capital gain is the selling of shares at a higher price than the purchase price. Multiple such trades can result in multiple capital gain accruing to the investor.
- COMPOUNDING: Compounding is the process in which an asset’s earnings, from either capital gains or profit, are reinvested to generate additional earnings over time. This Investment will generate earnings from initial principal and accumulated earnings from preceding periods.
- DIVIDEND REINVESTMENT: This is the process whereby cash dividends earned from a company are reinvested for stock investment.