4.11 Stocks and Shares:
Introduction:
A legal entity is required
to be established to carry out activities like :
Manufacturing of Products
such as: food products, TVs, Refrigerators, Soaps and detergents…
Providing of services such
as: courier services, computer services, banks . . .
In order to start a
commercial activity what do we need?
1. Name for
the company which carries the activity
2. People who
can invest money in the company
3. Money
As per the Indian Companies
act of 1956, it is necessary to register the company in
How do companies get the
money?
Will any one give money
unless the people who established the organisation put their money first in the
company?
Unless the people who start
the organisation (called Promoters)
invest money, no financial organisation including Banks will provide
money. Later, one can ask friends and relatives and general public to invest
money in the organisation.
People who put their money
in the company are called shareholders (Owners) of the company.
With this introduction let
us define some terms
‘Joint
stock company’ is a business organisation (company) formed
under the Indian companies act 1956. After this the company needs to follow
guidelines rules of Indian Income tax and other company rules.
‘Share
capital’ is the amount put in by promoters, public to help the
company to start and operate the business. This consists of money invested by
promoters, friends and public.
Share capital can vary from
few Lakhs to few Crores.
The share capital is
divided in to number of equal parts each having a fixed value called face
value. Each of this is called a share. The people who invest money in the company and have
share are called share holders.
If the share
capital of a company is Rs 1,00,000. It can be divided in to
·
1,00,000 shares of each face value of Rs. 1(1,00,000 = 1,00,000*1)
·
20,000 shares of each face value of Rs. 5(1,00,000 = 20,000*5)
·
10,000 shares of each face value of Rs. 10(1,00,000 = 10,000*10)
·
1000 shares of each face value of Rs 100(1,00,000 = 1,000*100)
Whichever way the shares
are split we notice that
Share capital = Number of
shares * Face value of each share
Since company is not like
bank, what do share holders get from the company on the investment made by
them?
They do not get any
financial benefit till the company makes profit. Once the
company starts making profit, the share holders get part of the profit in
proportion to the investment (Number of shares) made by them. The profit
sharing among investors is distributed by way of ‘dividend’.
It is paid as % on the face value of the share.
Unlike a fixed interest % in the case of fixed deposits with Banks and
Post offices, there is no limit on the dividend %. There are examples of companies declaring
dividend in excess of 500%.This is possible when good companies make huge
profits. Similarly there are companies
who may not declare dividend for years together (10, 20 years).In such cases
investors do not get any return on their investment.
Category
of share holders
1. ‘Preference share holders’.
These types of share
holders get dividend at a fixed rate (not more) when company makes profit,
before dividend is paid to other category (‘Equity share holders’) of share
holders. In case of company closing down, preference share holders get their
capital (the amount of money they invested in the company) first before other
category of share holders get their investment back
2. ‘Equity share holders’
a) These types of share
holders get dividend only after divided is paid to Preference share holders.
The dividend % is not fixed nor it has a limit .When the company is closed
down, their investment amount in the company is returned last after repayment
to preference share holders.
(We can say that they get
high returns (good dividend) on their investment by taking a small risk (Lose
money on closure of company)
Buying of
shares
1. Some times companies call for application
(Public offerings) asking investors to invest in their companies. In response
to that, public make applications to become share holders of the companies
2. The shares could be bought from existing
share holders. In such cases, the shares are sold and bought through
‘middlemen’. These middlemen are called ‘share
brokers’. They charge certain % as commission (‘brokerage’) from both sellers and buyers as
service charges on the value of the sale/purchase.
‘Stock
exchange’ is a registered organization through which shares are
bought and sold. Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) are
two examples.The shares of good companies are always listed(registered) with a recognized Stock Exchange. We have
learnt that each share has a face value. If the company is doing very well then
there will be people who would like to be share holders of that company so that
they can get good dividends. In case of such companies there are few people who
would like to sell their shares, but there are many people who want to buy
these shares. Since demand is more than the supply, people who want to sell, will
ask much more price than the face value.
This is called ‘market price’. This
price is determined by sellers and buyers on a particular day and hence changes
from day to day. When the company is
doing well, normally its market price is more than its face value (In such
cases we pay ‘premium’ over and above its face value. If a
company is not doing good and is making losses for several years its market
price is normally less than its face value (Market value is at ‘discount’)
Number of shares bought = Investment/(Market value of one share)
Examples:
Though the face value of
State Bank Of India’ s share is Rs 5 there are days when it’s market price was
in the range of 100 to 600Rs.
Similarly we have case of
‘Infosys Ltd’ whose market price was in the range of 2000 to 3000 when the share’s face
value was Rs 5.
The market conditions,
growth prospects of the company and economic conditions of the country together
determine the market value of share of any company.
Note : Since the market price of a company’s share does not remain same, people
earn/lose money depending upon fluctuations in the market
(If the market price goes
up, investors make money; if it goes down they lose money)
‘Debenentures’
When companies need money
for their growth/expansion they can borrow money from Banks as loan. On the
loan they pay interest to Banks. Alternatively, Companies can also borrow money
from public by issuing what is called debenture certificates. The value of each
debenture certificate is normally in multiples of Rs 1000.Companies pay interest at a
fixed rate to holders of debentures on this value . The company returns the
debenture amount at the end of a fixed period (for ex. 5 years, 10 years…)
This way of borrowing is
advantageous to the company as normally
they get money at lesser interest rate
compared what banks charge to them on loans. It is beneficial to public also as
public get higher interest rate than what they may get from Banks. This way
Companies can avoid banks acting as ‘middleman’ between depositors. If the company closes down the debenture
holder may lose their money. Like shares, debentures also can be bought through
Stock Exchanges through share brokers. Like shares, debentures also have market
value.
4.11 Problem 1:
Ram purchases 200 shares of a company of Rs, 25 each at Rs 5 premium. The
company declares a dividend of 8%. Find out the amount invested and the
dividend received by Ram and also find out the rate of return
Return % is defined as
(Income/Investment)*100
Solution :÷
Face value of 1 share = Rs
25
Premium for 1 share = Rs 5
Total value of 1 share paid
by Ram= Rs 30(=25+5)
Total cost of 200 shares
(Ram’s Investment) = No of shares* cost of one share = 200*30 = Rs 6000
Dividend rate per share =
8%
Dividend amount per one
share of face value of Rs 25 = 25*8/100 = Rs 2(Note dividend is always paid on
the Face value and not on the market value)
Dividend on 200 shares =
Number of shares * dividend per one share=200*2 = Rs 400
Return % =
(Income/Investment)*100
= (400/6000)*100 = 6.67%
Note
that though the company declared dividend of 8% Ram got a return of only 6.67%
(Why? :
Because for a share of Rs 25, Ram paid Rs 30 a premium of Rs 5 extra)
4.11 Problem 2: Share capital of a company is Rs 3, 00,000
divided in to 3000 shares. At the end of a year the company distributes Rs
56,000 as dividend to all its share holders. How much a share holder will
receive as dividend if he holds 36 shares?
Solution :
Face value of one share = 
=
=100
Dividend per share = 
= 
=18.667
Dividend on 36 shares = 36*Dividend per share =
36*18.667 = Rs 672
4.11
Summary of learning
|
No |
Points learnt |
|
1 |
Share capital,
Preference shares, equity shares, Stock exchanges, Market price, dividend,
debentures |