Topics Covered in this article
The capital market provides an open opportunity for investors to invest and earn money by buying shares of companies. The share market in India can be traced back to 1875, with the start of the ‘Native Share and Stock Broker’s Association’, which is now called the Bombay Stock Exchange. This system incorporated the online mechanism for trading in 1995 through a platform known as BSE On-Line Trading or BOLT.
The purchase of shares, especially online, can seem like a daunting task for a beginner. The terms may be especially difficult to understand for a layman who is unfamiliar with company law. This article tries to breakdown the process to purchase a share in a company using the online route. It creates an easy to understand breakdown of all the terms used in online buying of shares.
There are two kinds of markets from where an investor can invest their money in a company- Primary market and secondary market. Primary market involves buying shares directly from the issuing company when it issues the initial public offering or IPO. On the other hand, a person can buy stocks from another person or company as well, through the secondary market, i.e. the stock market. This paper deals with the process of how to buy shares from the latter option.
Meaning of basic terms
The stock market can present itself as a complicated area for a common person. Therefore, before buying shares in a company, especially for beginners, it is necessary to understand the meaning of some basic terms. These terms have been given below-
- Capital market– It is the financial market where securities are bought and sold. It consists of two components- primary market (related to IPO) and secondary market (related to stock exchange). It generally deals with long-term securities.
- Securities– It is a financial asset which can be traded in the capital market and helps in raising the capital for public as well as private companies. There are three types of securities, equity securities which allow investors to hold ownership in a company, debt securities which are in the form of loans and hybrid securities, which have the elements of both debt and equity securities.
- Shares and Stock– Although stocks and shares are used interchangeably in layman terms, however, there is a slight difference. Shares are a unit of ownership in a company that can be individually held and sold. Stocks on the other hand are a cumulative form of shares which are generally held and sold together.
- Stock Exchange– It is a place where various financial instruments are traded, like commodities, stock and bonds. It helps to connect the stock sellers with stock buyers. A stock is traded on the stock exchange after it has gone through the process of Initial Public Offering or IPO.
- Stock Market– It is a broader term which includes all the stock exchanges in a particular area.
- Demat or dematerialised account– It is an electronic account via which the shares which are physically held by the account-holder are converted to an electronic form. This account can be linked to any bank account for the transfer of funds. It is quite similar to a bank account, as it allows the account holder to deposit as well as withdraw money.
- Depository– There are two depositories in India- National Securities Depository Limited or NSDL and Central Securities Depositories Limited or CSDL. They provide a link between the listed companies and the shareholders. It also provides a manner to buy shares online in a paper-less setting.
- Depository Participant- It is an agency, either in the form of financial institutions, banks or broker, which acts as an agent of the depository and streamlines the final issue of shares.
- Dividend– It is the payment made by the company to its shareholders when the company makes a profit. It may or may not be payable, depending upon company policies for the time being.
- Trading Account- It is a type of account which is utilized for the selling and buying shares or stock in a stock market. It provides a link between the investor’s Demat account and bank account and thereby, facilitates the process of buying and selling stocks in a smooth manner. A proof of address, identity card and proof of income is required to open a trading account.
- Securities Exchange Board of India or SEBI– It regulates the securities or capital market in India. It issues regulations and compliances for listed companies and tracks any malpractices that may be happening in the capital market.
- Stock Brokerage firms and Broker– Stock Brokerage firms are licensed agencies which act as an intermediary between the buyer and seller of securities who are trading on the stock exchange. These Stock Brokerage firms are regulated and financed by SEBI, i.e. Securities Exchange Board of India. These firms charge a commission or a flat rate for providing the services. It is necessary to hire a broker or Brokerage firms in order to trade on the Stock Exchanges in India.
- Listed and unlisted companies– Listed companies are those public companies which has entered into an agreement with the stock exchanges and whose shares are traded on stock exchanges. An unlisted company is a public or private company whose shares are not listed on the stock exchange and therefore it cannot trade its securities on any stock exchanges. A listed company also has to comply with SEBI Regulations, along with the provisions of the Companies Act, 2013.
- PAN card or Permanent Account Number– It is a 10-digit unique number allotted to an individual, which is utilized by the Government to determine the tax liability of an individual. It is also necessary for filing tax returns. It is a valid identity proof that is issued by a government authority.
- Unique Identification Number or UIN– It is an identification number which is to be provided in case the trade exceeds Rs. 1,00,000 on the stock exchange. It has been introduced by SEBI in order to create a database of all the investors taking part in the trades on the stock exchange.
- Sensex and Nifty– Sensex is the term used for sensitive index which shows the market index for the Bombay Stock Exchange or BSE. It provides the 30 most frequently traded companies on the BSE. Nifty shows the market index for National Stock Exchange. It provides the 50 most frequently traded companies on the NSE.
Procedure to purchase shares
The process to buy shares is provided as hereunder-
- Obtain PAN Card– The first step is to obtain a PAN card, which is a mandatory requirement to make any financial transactions, especially when it comes to share purchasing.
- Open a Bank account– A bank account is necessary for purchasing shares in the stock market. An existing bank account can be used for this purpose. In case the person does not have a bank account, a bank account should be opened in order to trade on the stock market.
- Open a Demat (dematerialised) account– On opening a Demat account, a unique Demat Account number is issued to each account holder, which is used while buying or selling of shares. A Demat account can only be opened with a Depository Participant, i.e. NSDL or CSDL, or both.
- Find a Brokerage firm– A Brokerage firm plays a major role in the selling and buying of shares as one cannot do so directly from the stock market and has to necessarily hire a broker. Choosing the firm is of critical importance, which is affected by the following factors- charges levied by the brokers, credibility of the firm, interface of their trading platform, other services provided by the firm, etc. Each firm charges differently for providing a trading platform and therefore, thorough research must be conducted before choosing the brokerage firm. A brokerage firm can be helpful in opening both Demat and Trading accounts.
- Open a Trading Account– A trading Account is also needed which links the Demat Account to a Bank Account. It is needed to purchase the shares. To open a Trading Account the following steps are to be followed-
- Choose Depository Participant
- Submit Trading Account Opening Form
- Fulfill Know Your Customers or KYC Norms
- Get yourself verified
- Sign the agreement copies
- Fund the Trading Account– The investor must ensure that there are enough funds in the bank account to purchase shares. The amount can be as per the budget of the investor.
- Research companies to invest in- It is necessary to research the companies that an investor wants to invest in as the future profits of the company will determine the dividend payable and the future market price of the shares. The investor can choose a company that they are familiar with as a consumer. Important factors to be considered to determine company’s position are annual reports of the company and the management’s annual letter to the shareholders. Other factors that can be seen are SEC filings, news about the company, the earning reports of the company, financial reports of the company, etc.
- Decide the number and types of shares to buy– The next step is to see the stock price of the company’s shares on the stock market and to determine the number of stocks the investor wishes to buy while keeping in mind their budget. Another factor to consider is the amount of ownership the investor will gain in the company upon buying such shares. For example, if a person wants to have a certain amount of control in a company, he or she may need to buy shares in excess of 30% of the total equity shares. Another thing to be considered is the type of shares to buy. For example, if an investor only wants access to dividends and no voting power, preference shares may be bought. If the investor wants to exercise voting rights, equity shares may be bought and so on. An investor can also buy fractional stocks by utilizing brokerage services which provide this option.
- Buy the shares through the Broker– Once the investor has decided upon which and how many shares to buy, he or she can buy the same through the broker by informing the broker about the price point at which the investor wants to buy the stock. The money is transferred from the bank account and the stock is automatically reflected in the Demat account. Thereafter, the investor becomes a shareholder of the company in which the shares are invested and is liable to receive dividend (if payable).
- Review the stock price regularly– After buying the shares, the investor must keep a check on the stock prices of the share bought, especially if the ultimate goal is to sell the shares at a higher price and make a profit.
- Get UIN if the investment is higher than Rs. 1 Lakh– If the investor wishes to make larger transactions, i.e. greater than Rs. 1,00,000, he or she has to obtain a UIN. A certain fee has to be deposited in order to obtain the UIN. It can be obtained by contacting a Point of Service agent, which are appointed by NSDL. A proof of identity and a proof of address also has to be submitted along with the registration fees.
Other optional things to do while buying stocks or shares in a company-
- Get some knowledge about the taxation laws in India to understand how your dividend is taxed.
- Get knowledge about investing in bonds and mutual funds.
- Understand basic brokerage terms and techniques.
- Look for further investment options and how to diversify your stock portfolio.
Some things to keep in mind while buying shares
Some pointers to keep in mind while buying stocks at the stock exchange are-
- The two main stock exchanges in India are Bombay Stock Exchange and National Stock Exchange. In United States of America, NASDAQ and the New York Stock Exchange are the major stock exchanges.
- Shares on the stock exchange can only be bought in case of public listed companies.
- Different stock brokerage services levy different amounts as commissions to act as an intermediary and facilitate the process of stock exchange.
- Along with the broking firm costs and the actual costs of the shares, there might be other costs associated with opening a bank account, trading account, Demat account, etc.
- The stock brokerage firms credibility and credentials should be checked thoroughly and one must take proper precautions while dealing with such firms.
- Shares can be of different types, namely equity shares (with voting rights), preference shares (without voting rights but with preference dividend distribution), preference shares with voting rights, etc. The kind of involvement the investor wants in a company determines the kinds of shares he or she will purchase.
- The dividends may not be paid even if the company is making profits. One reason for this may be that the company is investing the profits further and not releasing the dividends.
- The stock prices are dependent upon the performance of the company and therefore, a proper analysis of the company should be made before investing in the company.
Advantages and Disadvantages of Purchasing shares
Advantages of purchasing a share
- The share-owner receives regular dividend from the company, if payable.
- The share-owner can sell the share at a higher price than what he bought it at, if the company is performing well at the stock market.
- The share-owner becomes a part owner of the company and if enough shares are bought, can play a significant role in the appointment of directors in the company and thereby, have some control over the company.
Disadvantages of purchasing a share
- Even a company which was performing well earlier may perform poorly after buying the stock due to external or internal factors. The share price may resultantly fall and the share-owner may incur a loss on selling the shares of a poorly performing company.
- The company may not issue dividends due to various reasons, therefore, no regular earnings for the shareholder.
- If the shareholder does not own enough shares in the company, he or she may not have control over the company.
- If the shareholder does not research properly about the company, the money may be invested in a poorly-performing company which will lead to losses.
The process to buy shares via a stock market may seem like a challenge, but with proper knowledge and resources and especially with the advent of online trading, this process can be simplified and produce itself as a huge earning opportunity for the investor. By keeping oneself updated with Sensex, Nifty and the changes in the capital market, an investor can earn large sums of money. However, one must stay cautious while dealing with the stock market and brokerage firms as there may be many fluctuations which may lead to huge losses and leave the investor under debts.