Thursday, September 01, 2011

How to invest money in share?

 Learn the basics of shares and investment

Shares represents a portion of total ownership of a company. Take example of Tata Steel, as on today Tata Steel has issued 88.7214 Crore shares in the market (called outstanding shares). What does this mean, it means that total Net worth of Tata Steel is divided into 88.72 parts called shares.

Suppose you own 1,00,000 shares of Tata Steel,  it means you are actually owning 1,00,000/(88.72 crore) x 100 = 0.011% of total ownership of Tata Steel. So shares represent fractional ownership of a company, when you buy a share you are actually becoming a proportional owner of that company.

In order to understand why company issue shares, we have to refer to the balance sheet of the companies. In balance sheet of the company the share/ equity is listed under heading called “Source of Funds”. All companies require money to fund their growth, in order to raise capital issuing shares is a very useful way of raising the funds. Shares is an excellent form of raising funds/ capital because by doing this the business owners are not obliged to pay back this money to shareholders.

Even the company is not obliged to pay the interest on the accumulated fund. So you will ask that what shareholders get in return? Shareholders are eligible for dividends. Shareholders are ‘share-holders’ because they share the risk of doing business as if they are owners of the company. If there is loss they share the loss in terms of no-dividend disbursements and loss of market value of share and in case of profits they earn dividends.

Net profits also increases the worth of the company. By doing profits companies not only share it by distributing dividends to shareholders but a portion of the profit also goes to the ‘Cash Reserves’ of the company which increases its Net Worth. Also, companies use the extra cash/ net profits to fund their expansion and modernization projects.

All of the above three points discussed about net profits i.e. (1) Disbursements of Dividends (2) Carryover to Balance Sheet as cash reserves and (3) Using balance net profits to fund expansion and growth projects directly or indirectly increases shareholders value. So by knowing how to invest money in share you are actually creating your way to generate additional source of income by putting your money to “calculated risk”.

How to invest money in share by taking calculated risk?
It is must easier said than done, calculating risk is not easy. Your knowledge about companies fundamentals will give you the advantage of analyzing the risk better. In order to know how to invest in share effectively, one must know how to calculate risk.

How to calculate risk? This is not as difficult as it may sound. What actually we have to do to invest money in share? Let’s talk about steps that we need to check in order to calculate the risk and invest in share to earn profits in long term:

Step 1 – Always invest in big companies which are market leaders in their own sectors
Step 2 – Always invest in companies which has strong financial strengths line high current ration (above 2) and low long term debt equity ratio (below 2)
Step 3 – Always invest in companies which has shown ability to increase the earning per share (EPS) over a period of last 10 years. EPS growth rate of above 13% CAGR over a period of last 10 years is good.
Step 4 – Always invest in companies which has shared consistently the profits of companies with their shareholders in the form of dividends. Dividend yield of higher than 4% is a good indicator.
Step 5 – Always invest in companies which has Average P/E ratio of less than 15.
Step 6 – Generally investing in big companies and market leaders will have high P/E ratio. But high EPS growth rate will justify the high P/E ratio. The parameter called PEG ratio (PEG / EPS growth rate). Invest in companies which has PEG ratio of less than one.
Step 7 – Invest in companies which has Price to Book value ratio of less than 1.5
Step 8 – Invest in companies which is profitable in doing the business. High operating margins, net profit margins, high return on net worth as compared to its competitors is parameters to be considered for long term investors.
Step 9 – Invest in companies which has strong order booking in future.

Investing in share is intelligent process of letting your money to work. Your decision to open a trading and demat account is the first step to make your money to work. Share is not a way to gamble and make money. Instead shares make you a proportional owner of its companies and it calls you to think like a business owner and not like a trader. Knowing to evaluate the fundamental strength and future growth prospects of the company is the mark of a true investor. If one wants to really know how to invest money in share, then go and do it yourself.

Have a happy investing.
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