How to earn money from the share market
By investing in shares, one can earn either through capital appreciation, i.e., on the gains made on capital, or income in the form of dividends.
Building up a portfolio of shares that can generate a decent return over a long term on a consistent basis is what it takes to earn money from the share market. However, the reality is that investing directly in the stock market may not be everybody's cup of tea as equity has always been a volatile asset class with no guarantee of returns. The only silver lining is that over longer period of time, equity has been able to deliver higher than inflation-adjusted returns among all asset classes.
First, we look at how money can be made by buying shares. There are two primary ways to earn money from shares - through capital appreciation and from dividends.
Earning from capital appreciation
By investing in shares, one can expect to earn through capital appreciation, i.e., on the gains made on the capital (principal invested) when the share price rises. The gains or the profits from shares can go as high as 100 percent or more. There is, however, no guarantee of capital appreciation. The probability of the market prices remaining lower than the buy price always exists.
Earning from dividends
Apart from capital gains on shares, investors may expect income in the form of dividends. A company distributes profits to its shareholders by declaring partial or full dividends. In most cases, the company partially distributes profits and keeps the rest for other purposes, such as expansion. The dividends are distributed per share. If a company decides to give Rs 10 per share, and if the face value of the share is Rs 10, it is called 100 per cent dividend.
The formula for computing the dividend yield is:
Dividend Yield = Cash Dividend per share / Market Price per share * 100.
So, if the market price is Rs 120 and the dividend declared is Rs 4 per share, the dividend yield is 3.33 percent.
By investing in shares, the risk of losing a major part of one's capital exists, unless one employs hedging mechanism including stop-loss in place to minimise the losses.
So, if you still want to earn money from stocks, here are a few things to know and be aware of to take informed investing decisions:
Share markets - primary and secondary
The stock market is divided into two main categories: primary and secondary market. In the primary market, securities are issued and subsequently listed on stock exchanges. Trading in these securities happens in the secondary market.
A public issue introduced in the primary market can be of two types-an initial public offering (IPO), or a follow-on public offering (FPO). An IPO is used when an unlisted company wants to raise equity capital by issuing shares. It results in the company's shares getting listed on a stock exchange. In an FPO, a listed company issues shares to the public. It can be either a fresh issue or an offer for sale.
Further, there are investors who look for fundamental strengths in a company's stock and invest for a medium to long term, while another type are the traders who look at technical charts to buy and sell during intra-day or over few days. As a retail investor, consider investing in shares for the long term keeping the fundamentals of the company in context.
Factors impacting share price
To earn money from direct equity, one needs to know the factors impacting the share price. A company's share price does not move independently. Several internal and external factors are responsible for it. When a company is expected to grow faster, more people want to hold the stock. This leads to higher demand for the stock in the market, which results in higher prices. Further, acquisition plans, buyback offer, announcement of bonus, and splitting of share impact prices in the short term.
In addition, there are macroeconomic factors such as GDP, inflation, interest rates impacting performance and thereby stock prices. If the economy is doing well, the demand for goods and services will be higher, resulting in more profits for companies. Further, high inflation means higher prices and consumers will be able to buy fewer goods and services, hurting company's sales and profits.
Stocks selection requires knowledge of a vast range of subjects such as economics, finance, and corporate law. However, if you lack rigorous training in these subjects you can use some basic principles. First of all, you should try to understand the company's business. You should read the company's financial statements such as income statement, balance sheet, and cash flows. Don't just focus on earnings. Balance sheet and cash flows are even more important.
After you have analysed the company's financial health, look at its valuation. Strong balance sheet numbers coupled with lower valuations compared to peers or the index makes a strong case to buy. You can use various sources to gather information on stocks. The first one is the website of the exchange where the stock is listed. Here, you can find financial results and company announcements. Companies also publish their financials on their websites.
Building a diversified portfolio
Start by putting your money in different stocks, which is also called diversification. This diversification should happen across sectors and also across market capitalisation of stocks. Concentrating in one sector or putting all your funds in mid-cap stocks may not be the right thing to do.
Diversifying across sectors or industries helps if the economic environment is not favourable for any one sector as each sector has its own typical set of factors that impact the performance of companies. These include the economic environment, cyclical nature of business and the government policies. By diversifying, one is actually creating a share portfolio, the overall return of which matters and not return from any 1-2 stock out of it.
For starters, it's better to stick to large-cap stocks which mostly comprise the index. The mid-cap index can be a good starting point for buying into mid-cap stocks. Over time, one may look at other emerging companies but only after careful analysis. Ideally, small-caps should form just a small portion.
Never try to time the market
Buying low and selling high is always a dream of every investor. However, knowing the bottom or the peak in a stock's history always comes to be known in hindsight. Rather than trying to time the market, focus on the time spent in the market. Waiting for the stock price to lower further down may not even come and many investors are left out in the waiting game. It's better to stagger one's investment at different price levels.
Avoid herd mentality
When the stock price shoots up, many investors feel left out. At times, without understanding the business and the company financials, new investors jump on as herd mentality takes over. Such a move can be financially damaging as it may amount to pure speculation and most investors could be at the mercy of big operators.
Further, when stock prices decline hugely in a span of few days, there could be unanswered questions and fear factors leading to its fall. The price reversal can be equally swift. Avoid the temptation to take decisions based on rumours or speculative reports.
Finally, when the markets are in the grip of bears and stocks keep falling for days together, herd mentality caves in. The world's greatest investor, Warren Buffett, was surely not wrong when he said, "Be fearful when others are greedy, and be greedy when others are fearful!"
Keep emotion away
Keep emotional reasoning away while taking investing decisions in shares. Many investors have been losing money in stock markets due to their inability to control emotions, particularly fear and greed. In a bull market, the lure of quick wealth is difficult to resist, while in a bear market when prices crash, the fear takes over and investors sell even at huge losses.
When to sell
At times, stock markets could remain flat for a long period, while at other times it can be extremely volatile. Your decision to exit should ideally not be based on short-term market movements rather on your stock selection. If there are no fundamental changes in your stocks, including its financials and businesses, stick to it. Risk is inherent while investing in stocks and hence, one should be able to stomach the risk of seeing the share price slide down considerably. Keep some portion of cash in hand to make use of market opportunities. If your stock has performed well, booking profits may not be bad idea.