HOW STOCK MARKET AFFECT THE PRICE OF SHARES AND SITUATIONS

By virtue of being a public company, the company is now liable to disclose all information related to the company to the public. The shares of a public limited company are traded on the stock exchanges on a daily basis.

There are few reasons why market participants trade stocks. We will explore these reasons in this chapter.

What really is the stock market?


The stock market is an electronic market place. Buyers and sellers meet and trade their point of view.

For example, consider the situation of Infosys.  Infosys is facing a succession issue, and most of its senior level management personnel are quitting the company for internal reasons. It seems like the leadership vacuum is weighing down the company’s reputation heavily. As a result, the stock price dropped to Rs.3,000 all the way from Rs.3,500. Whenever there are new reports regarding Infosys management change, the stock prices react to it.

Assume there are two traders – T1 and T2.

T1’s point of view on Infosys - The stock price is likely to go down further because the company will find it challenging to find a new CEO.

If T1 trades as per his point of view, he should be a seller of the Infosys stock.

T2, however views the same situation in a different light and therefore has a different point of view – According to him, the stock price of Infosys has over reacted to the succession issue and soon the company will find a great leader, after whose appointment the stock price will move upwards.

If T2 trades as per his point of view, he should be a buyer of the Infosys stock. 

So at, Rs.3, 000 T1 will be a seller, and T2 will be a buyer in Infosys.

Now both T1 and T2 will place orders to sell and buy the stocks respectively through their respective stock brokers. The stock broker, obviously routes it to the stock exchange.

The stock exchange has to ensure that these two orders are matched, and the trade gets executed. This is the primary job of the stock market – to create a market place for the buyer and seller.

The stock market is a place where market participants can access any publicly listed company and trade from their point of view, as long as there are other participants who have an opposing point of view. After all, different opinions are what make a market.

What moves the stock?


Let us continue with the Infosys example to understand how stocks really move. Imagine you are a market participant tracking Infosys.

It is 10:00 AM on 11th June 2014 ,and the price of Infosys is 3000. The management makes a statement to the press that they have managed to find a new CEO who is expected to steer the company to greater heights. They are confident on his capabilities and they are sure that the new CEO will deliver much more than what is expected out of him.

Two questions –

a.How will the stock price of Infosys react to this news?
b.If you were to place a trade on Infosys, what would it be? Would be a buy or a sell?

The answer to the first question is quite simple, the stock price will move up.

Infosys had a leadership issue, and the company has fixed it. When positive announcements are made market participants tend to buy the stock at any given price and this cascades into a stock price rally.

In this particular case, the stock moves up because of two reasons. One, the leadership issue has been fixed, and two, there is also an expectation that the new CEO will steer the company to greater heights.

The answer to the second question is now quite simple; you buy Infosys stocks considering the fact that there is good news surrounding the stock.

Now, moving forward in the same day, at 12:30 PM ‘The National Association of Software & Services company’, popularly abbreviated as NASSCOM makes a statement. For those who are not aware, NASSCOM is a trade association of Indian IT companies. NASSCOM is considered to be a very powerful organization and whatever they say has an impact on the IT industry.

The NASSCOM makes a statement stating that the customer’s IT budget seems to have come down by 15%, and this could have an impact on the industry going forward.

By 12:30 PM let us assume Infosys is trading at 3030. Few questions for you..

a.How does this new information impact Infosys?
b.If you were to initiate a new trade with this information what would it be?
c.What would happen to the other IT stocks in the market?

The answers to the above questions are quite simple. Before we start answering these questions, let us analyze NASSCOM’s statement in a bit more detail.

NASSCOM says that the customer’s IT budget is likely to shrink by 15%. This means the revenues and the profits of IT companies are most likely to go down soon. This is not great news for the IT industry.

Let us now try and answer the above questions..

a.Infosys being a leading IT major in the country will react to this news. The reaction could be mixed one because earlier during the day there was good news specific to Infosys. However a 15% decline in revenue is a serious matter and hence Infosys stocks are likely to trade lower

b.At 3030, if one were to initiate a new trade based on the new information, it would be a sell on Infosys

c.The information released by NASSCOM is applicable to the entire IT stocks and not just Infosys. Hence all IT companies are likely to witness a selling pressure.

So as you notice, market participants react to news and events and their reaction translates to price movements! This is what makes the stocks move.

At this stage you may have a very practical and valid question brewing in your mind. You may be thinking what if there is no news today about a particular company? Will the stock price stay flat and not move at all?

Well, the answer is both yes and no, and it really depends on the company in focus.

For example let us assume there is absolutely no news concerning two different companies..

1. Reliance Industries Limited
2. Shree Lakshmi Sugar Mills

As we all know, Reliance is one the largest companies in the country and regardless of whether there is news or not, market participants would like to buy or sell the company’s shares and therefore the price moves constantly.

The second company is a relatively unknown and therefore may not attract market participant’s attention as there is no news or event surrounding this company. Under such circumstances, the stock price may not move or even if it does it may be very marginal.

To summarize, the price moves because of expectation of news and events. The news or events can be directly related to the company, industry or the economy as a whole. For instance the appointment of Narendra Modi as the Indian Prime Minister was perceived as positive news and therefore the whole stock market moved.

In some cases there would be no news but still the price could move due to the demand and supply situation.

How does the stock get traded?


You have decided to buy 200 shares of Infosys at 3030, and hold on to it for 1 year. How does it actually work? What is the exact process to buy it? What happens after you buy it?

Luckily there are systems in place which are fairly well integrated.

With your decision to buy Infosys, you need to login to your trading account (provided by your stock broker) and place an order to buy Infosys. Once you place an order, an order ticket gets generated containing the following details:

a. Details of your trading account through which you intend to buy Infosys shares – therefore your identity is reveled.
b. The price at which you intend to buy Infosys
c.The number of shares you intend to buy

Before your broker transmits this order to the exchange he needs to ensure you have sufficient money to buy these shares. If yes, then this order ticket hits the stock exchange. Once the order hits the market the stock exchange (through their order matching algorithm) tries to find a seller who is willing to sell you 200 shares of Infosys at 3030.

Now the seller could be 1 person willing to sell the entire 200 shares at 3030 or it could be 10 people selling 20 shares each or it could be 2 people selling 1 and 199 shares respectively. The permutation and combination does not really matter. From your perspective, all you need is 200 shares of Infosys at 3030 and you have placed an order for the same. The stock exchange ensures the shares are available to you as long as there are sellers in the market.

Once the trade is executed, the shares will be electronically credited to your DEMAT account. Likewise the shares will be electronically debited from the sellers DEMAT account.

What happens after you own a stock?


After you buy the shares, the shares will now reside in your DEMAT account. You are now a part owner of the company, to the extent of your share holding. To give you a perspective, if you own 200 shares of Infosys then you own 0.000035% of Infosys.

By virtue of owning the shares you are entitled to few corporate benefits like dividends, stock split, bonus, rights issue, voting rights etc. We will explore all these shareholder privileges at a later stage.

A note on holding period


Holding period is defined as the period during which you intend to hold the stock. You may be surprised to know that the holding period could be as short as few minutes to as long as ‘forever’. When the legendary investor Warren Buffet was asked what his favorite holding period was, he in fact replied ‘forever’.

In the earlier example quoted in this chapter, we illustrated how Infosys stocks moved from 3000 to 3016 in a matter of 5 minutes. Well, this is not a bad return after all for a 5 Minute holding period! If you are satisfied with it you can very well close the trade and move on to find another opportunity. Just to remind you, this is very much possible in real markets. When things are hot, such moves are quite common.

I hope you understand the whole process of stock in the stock market . If you have any query or suggestions please write down in the comment .

NSCCL AND ICCL

NSCCL – National Security Clearing Corporation Ltd and Indian Clearing Corporation are wholly owned subsidiaries of National Stock Exchange and Bombay Stock Exchange respectively.

The job of the clearing corporation is to ensure guaranteed settlement of your trades/ transactions. For example if you were to buy 1 share of Biocon at Rs.446 per share there must be someone who has sold that 1 share to you at Rs.446 . For this transaction, you will be debited Rs.446 from your trading account and someone must be credited that Rs.446 toward the sale of Biocon. In a typical transaction like this the clearing corporation’s role is to ensure the following:

a) Identify the buyer and seller and match the debit and credit process
b) Ensure no defaults – The clearing corporation also ensures there are no defaults by either party. For instance the seller after selling the shares should not be in a position to back out thereby defaulting in his transaction.

For all practical purposes, its ok not to know much about NSCCL or ICCL simply because, you as a trader or investor would not be interacting with these agencies directly. You just need to be aware that there are certain professional institutions which are heavily regulated and they work towards smooth settlement, and efficient clearing activity.

IPO SEQUENCE OF EVENTS

Needless to say each and every step involved in the IPO sequence has to happen under the SEBI guidelines. In general, the following are the sequence of steps involved.

• Appoint a merchant banker. In case of a large public issue, the company can appoint more than 1 merchant banker

• Apply to SEBI with a registration statement – The registration statement contains details on what the company does, why the company plans to go public and the financial health of the company

• Getting a nod from SEBI – Once SEBI receives the registration statement, SEBI takes a call on whether to issue a go ahead or a ‘no go’ to the IPO

• DRHP – If the company gets the initial SEBI nod, then the company needs to prepare the DRHP. A DRHP is a document that gets circulated to the public. Along with a lot of information, DRHP should contain the following details..

a.The estimated size of the IPO
b.The estimated number of shares being offered to public
c.Why the company wants to go public and how does the company plan to utilize the funds along with the timeline projection of fund utilization
d.Business description including the revenue model, expenditure details
e.Complete financial statements
f.Management Discussion and Analysis – how the company perceives the future business operations to emerge
g.Risks involved in the business
h.Management details and their background

• Market the IPO – This would involve TV and print advertisements in order to build awareness about the company and its IPO offering. This process is also called the IPO road show

• Fix the price band – Decide the price band between which the company would like to go public. Of course this can’t be way off the general perception. If it is, then the public will not subscribe for the IPO

• Book Building – Once the road show is done and price band fixed the company now has to officially open the window during which the public can subscribe for shares. For example, if the price band is between Rs.100 and Rs.120, then the public can actually choose a price they think is fair enough for the IPO issue. The process of collecting all these price points along with the respective quantities is called Book Building. Book building is perceived as an effective price discovery method

• Closure – After the book building window is closed (generally open for few days) then the price point at which the issue gets listed is decided. This price point is usually that price at which maximum bids have been received.

• Listing Day – This is the day when the company actually gets listed on the stock exchange. The listing price is the price discovered through the book building process.

THE ANGLES IN ORIGIN OF BUSINESS

Let us imagine a budding entrepreneur with a brilliant business idea – to manufacture highly fashionable, organic cotton t-shirts. The designs are unique, has attractive price points and the best quality cotton is used to make these t-shirts. He is confident that the business will be successful, and is all enthusiastic to launch the idea into a business.

As a typical entrepreneur he is likely to be hit by the typical problem – where would he get the money to fund the idea? Assuming the entrepreneur has no business background he will not attract any serious investor at the initial stage. Chances are, he would approach his family and friends to pitch the idea and raise some money. He could approach the bank for a loan as well but this would not be the best option.

Let us assume that he pools in his own money and also convinces two of his good friends to invest in his business. Because these two friends are investing at the pre revenue stage and taking a blind bet on the entrepreneur they would be called the Angel investors. Please note, the money from the angels is not a loan, it is actually an investment made by them.

So let us imagine that the promoter along with the angels raise INR 5 Crore in capital. This initial money that he gets to kick start his business is called ‘The Seed Fund’. It is important to note that the seed fund will not sit in the entrepreneur’s (also called the promoter) personal bank account but instead sits in the company’s bank account. Once the seed capital hits the company’s bank account, the money will be referred to as the initial share capital of the company.

In return of the initial seed investment, the original three (promoter plus 2 angels) will be issued share certificates of the company which entitles them an ownership in the company.

The only asset that the company has at this stage is cash of INR 5 Crs, hence the value of the company is also INR 5 Crs. This is called the company’s valuation.

Issuing shares is quite simple, the company assumes that each share is worth Rs.10 and because there is Rs.5 crore as share capital, there has to be 50 lakh shares with each share worth Rs.10. In this context, Rs.10 is called the ‘Face value’ (FV) of the share. The face value could be any number. If the FV is Rs.5, then the number of shares would be 1 crore, so on and so forth.

The total of 50 lakh shares is called the Authorized shares of the company. These shares have to be allotted amongst the promoter and two angels plus the company has to retain some amount of shares with itself to be issued in the future.

So let us assume the promoter retains 40% of the shares and the two angels get 5% each and the company retains 50% of the shares. Since the promoter and two angels own 50% of the shares, this allotted portion is called Issued shares.

The share holding pattern of this company would look something like this..


Please note the balance 50% of the shares totaling 2,500,000 equity shares are retained by the company. These shares are authorized but not allotted.

Now backed by a good company structure and a healthy seed fund the promoter kick starts his business operations. He wants to move cautiously, hence he decides to open just one small manufacturing unit and one store to retail his product.

DEPOSITORY AND DEPOSITORY PARTICIPANTS

When you buy a property the only way to identify and claim that you actually own the property is by producing the property papers. Hence it becomes extremely important to store the property papers in a safe and secure place.

Likewise when you buy a share (a share represents a part ownership in a company) the only way to claim your ownership is by producing your share certificate. A share certificate is nothing but a piece of document entitling you as the owner of the shares in a company.

Before 1996 the share certificate was in paper format however post 1996, the share certificates were converted to digital form. The process of converting paper format share certificate into digital format share certificate is called “Dematerialization” often abbreviated as DEMAT.

The share certificate in DEMAT format has to be stored digitally. The storage place for the digital share certificate is the ‘DEMAT Account’. A Depository is a financial intermediary which offers the service of Demat account. A DEMAT account in your name will have all the shares in electronic format you have bought. Think of DEMAT account as a digital vault for your shares.

As you may have guessed, the trading account from your broker and the DEMAT account from the Depository are interlinked.

So for example if your idea is to buy Infosys shares then all you need to do is open your trading account, look for the prices of Infosys and buy it. Once the transaction is complete, the role of your trading account is done. After you buy, the shares of Infosys will automatically come and sit in your DEMAT account.

Likewise when you wish to sell Infosys shares, all you have to do is open your trading account and sell the stock. This takes care of the transaction part…however in the backend, the shares which are sitting in your DEMAT account will get debited, and the shares move out of your DEMAT account.

At present there are only two depositaries offering you DEMAT account services. They are The National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited. There is virtually no difference between the two and both of them operate under strict SEBI regulations.

Just like the way you cannot walk into National Stock Exchange’s office to open a trading account, you cannot walk into a Depository to open a DEMAT account. To open a DEMAT account you need to liaison with a Depository Participant (DP). A DP helps you set up your DEMAT account with a Depository. A DP acts as an agent to the Depository. Needless to say, even the DP is governed by the regulations laid out by the SEBI.