Lots of individuals have no idea what stock markets are. To them, it is just something they see in the business section or news that doesn’t make sense, and for this reason, they have no idea how lucrative it can be.
The knowledge of the stock markets isn’t complete without defining the initial public offering (IPO). An IPO, as the name hints, refers to the first time a private company offers its shares/stock to the public.
The issuant of the stocks can be small companies or businesses looking for growth expansion. Large private enterprises can also issue their stocks to be traded publicly.
Through the help of an underwriting firm, a company wishing to offer an IPO establishes they type of security to offer, the best price, the perfect time to bring it to the market, as well as the best number of shares to be traded.
This is where the stock markets come in. A stock market, in layman terms, is a venue where people looking to trade in shares (stocks of a company) come together and decide on a price to trade. Although some exchanges are physical, nowadays stock exchanges are largely done virtually where the trading occurs and the records updated electronically.
In a stock market, shareholders of certain companies and corporations trade their shares with potential customers. It is worth noting that the company listed on the stock market do not trade – buy or sell – their shares regularly. Sometimes, they may buy back the stock or offer new shares, but not daily. This often occurs outside their framework.
What this means is that when you buy shares on the stock market, you are not buying it from the listed company but from another shareholder. The same goes for when you sell the shares. Another investor buys them from you.
Many shy away from stock markets due to unpredictability. Others do not know that in a stock market, the rules are subject to the law of best practices and equality in the business environment.
In Kenya, for instance, the Capital Markets Authority is the Government Regulator. It is mandated to license and monitor the capital markets as well as to approve the public offers and listings of securities traded at the Nairobi Stock Exchange (NSE).
How are the prices for shares set in a stock market? There are several ways, but the predominant one is the auction process where buyers and sellers place bids and offer to buy or sell.
When one wishes to buy a share at a specific price, that is a bid. On the other hand, an offer, also known as ask, is the price at which somebody wishes to sell. When the two coincide, a transaction is made.
How you make money and how you calculate the profits or losses is through a simple process. What you earn depends on the initial dividend yield on cost, the intrinsic value per share, and the price-to-earnings ratio
You can collect cash dividends or share on the consistent growth of the primary earnings per share, or you can earn more or less for the profit the company generates depending on the economic fluctuations – the panics and the optimism – which usually drives the price-to-earnings ratio.
For example, if company X pays a dividend of 24 shillings per share, and you own a total of 1000 shares, at the end of the year you will earn 24, 000 shillings.
If you buy, let’s say 100 shares of X at 400 shillings per share on March 31st, 2018, your total investment value is 40,000. If you sell all the 100 shares by the end of the financial year for 480 shillings per share, your proceeds from the sale will be 48,000. Then you can calculate your gain as (48,000 – 40,000) / 40,000 = 20%.
Alternatively, you can calculate your gain using the per share price, which would look like (480 – 400) / 400 = 20%.
This same process can be used if you want to know how much you have made or lost without selling. You can use the current market price in the place of the price sold, but the figures will be unrealized.
This is the basic formula used every day to determine to find out the dynamics of the percentage points indexes, stocks, interest rates, and so on in a given period of time. For instance, if the company X opens at 64 shillings and closes at 76 shillings on a specific day, the percentage change over the day will be (76 – 64) / 64 = 18.75.
To determine the price per earnings (P/E) ratio, you can divide the stock price by Earning Per Share. For example, if company X on March 31st, 2018 trades at 400 shillings per share with an EPS of 150 shillings, the P/E ratio is 400/150 = 2.7 shillings.
This essentially means that potential investors are willing to pay 2.7 shillings for every shilling of earnings that company X has.
Things to Keep in Mind
Now here is something funny. The stock market doesn’t go according to your plans, it is unpredictable and has no agenda. In a nutshell, it is very risky, but why is this a good thing?
The answer is simple. There is no clear path to success. The difference between the rich and the poor is that the rich often invest in risk. So, before you invest in stock markets, understand the fundamentals.
There you have it! Trade your way in the stock market and become a billionaire.