Where should I invest?
Tina is on cloud nine as she has gotten a job in a Multinational firm in South Delhi. Although it’s a great occasion to celebrate the first step she has taken towards being financially independent, she is apprehensive towards stock investment. Her fear is due to her lack of awareness in this field of investment. I believe there are many people like Tina who are confused and scared to invest in the stock market. In this article, I will explore some of the basic concepts and give an overview of where to invest.
Let me begin by asking a question,.
“What is a stock?”
A stock is a type of security that indicates ownership in a corporation. The next question is “How are stocks classified?” The answer is simple. There are two types of stocks that a company issues: Common stock and preferred stock. For example, if Tina buys stock from company XYZ, she not only has an ownership in the company but also has the right to vote in shareholder meetings. Apart from it, she will also be paid dividends if the company makes a profit. Unlike common stock, a preferred stockholder is not granted with the voting rights in a shareholder meeting but has its own advantages. When a company goes bankrupt, the company usually pays the preferred shareholders first before a common shareholder like Tina.
Now a beginner like Tina is bombarded with a plethora of companies and doesn’t know how to determine a company’s value. How does Tina find the market value of a company that she wants to buy stocks from? Firstly, she needs to understand this jargon “Market Capitalization” In simple words; she needs to multiply all the outstanding shares of a stock by the price of a single share. For example, if company XYZ has 2 Million shares outstanding and the price of a share is 10$, then the market capitalization is 20 Million.
Securities Exchange Board of India (SEBI) has categorized stocks based on the market capitalization as Large Cap, Medium Cap, and Small Cap. Large Caps are the first 100 companies ranked according to their market capitalization and these are usually well-established companies and they grow at a slower rate. In other words, they have lesser growth potential when compared to Small Caps or Medium Caps. This is a good option for conservative investors as it requires a lesser risk appetite. Medium Caps are the next 150 companies after the Large Caps. These are also well-established companies but their businesses are not as stable as a Large Cap but have the potential to become a Large Cap in the future. Furthermore, they have plenty of growth potential to give good future returns. Small caps are those companies that are after the Medium caps. These stocks are the smallest in terms of market capitalization and hence they are very risky. Always remember that the risk is proportional to the returns that you will earn from a stock. This means that when Tina buys shares of a Small Cap, she is also expecting a higher return for the risk she has taken today. On the other hand, if she is risk-averse, she would buy shares of a Large Cap. As the risk she has taken a relatively lower risk, the return that she will get in the future will also be less. As a rule of thumb, one should also remember that the return from the stock market depends on your risk appetite and the duration for which you hold your stocks.
Even though calculating market capitalization is a great measure of value, do not rely on just one parameter. This is because knowledge is crucial for stock investing and should consider many other factors before deciding to buy a stock. I hope that this article gave you a fair idea about stock, types of stocks, market capitalization and the categories of market capitalization.
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· Economic Times. June 29, 2019. https://economictimes.indiatimes.com/markets/stocks/news/midcaps-are-where-the-money-is-but-you-must-know-certain-things-about-them-first/articleshow/70000915.cms?from=mdr.
· Mlajenovic, Paul. Stock Investing for Dummies. John Wiley & Sons.