The Stock Exchange is a place where shares of listed companies are bought and sold. Companies list themselves on the stock exchange to raise capital. Shares of companies are traded, after they are listed, through a process of Initial Public Offering (IPO) or Secondary Public Offering (SPO). The share purchase represents ownership of the shareholder in a company to the extent of amount contributed by the investor to the capital of that company.
Corporate Bonds (Term Finance Certificates – TFCs etc.) and Government Debt Securities – GDS (Treasury Bills etc.) are also listed and traded on the Stock Exchange. Bonds are listed by a company that wants to raise capital in return for fixed periodic payments as mark-up and the eventual return of principal to the investor. GDS are listed by the Government to raise capital whereby the securities give fixed periodic returns as profit with eventual return of principal to the investor.
A company floats its shares for the first time through an IPO in the share market. These shares can be purchased by filling and submitting the share subscription form along with the payment of subscription amount through cheque (or through any other instrument of payment recommended by the issuer company) at a branch of the designated bank(s). The shares are subscribed at a pre-designated price. In an SPO, shares are offered by a listed company by way of issuing new shares, called Right Shares, or through off-loading of more shares (held by directors and others) in the market. The share price is set on the stock exchange platform as the shares are bought and sold.
Pakistan Stock Exchange (PSX) has 558 listed companies distributed amongst 40 sectors. There are 7 Indices listed on PSX board. Part of the PSX ecosystem are the CDC (Central Depository Company) through which delivery of shares takes place, and NCCPL (National Clearing Company of Pakistan Limited) through which settlement of shares takes place.
Potential Investors are advised to contact a TREC (Trading Rights Entitlement Certificate) holder/ licensed brokerage firm for their account opening and trading on the Stock Exchange.
Investor Dos & Don’ts
- Primary market/ IPO – Dos: A (prospective) investor must read the Prospectus/ Abridged
Prospectus issued against an IPO carefully and note the following:
- Risk factors pertaining to the issue.
- Financials of the issuer.
- Object of the issue.
- Outstanding litigations & defaults, if any.
- Business overview.
- Background of promoters.
- Instructions before making application.
- Primary market/ IPO –
- Do not fall prey to market rumours.
- Do not go by any implicit/ explicit promise made by anyone.
- Do not invest simply based on the bullish trend of the market industry/ issuer company.
- Do not bank on the price of the shares of the issuer company going up in the short run.
- Do not invest just because others are doing it also.
- Do not invest just because the issuer company has a good reputation. Study the details behind the issue.
- Secondary Market– Dos:
- Transact only through Stock Exchange.
- Deal only through registered brokers/ TREC holders of PSX with valid license for brokerage issued by SECP.
- Complete all account opening formalities properly
- Read & properly understand the risk associated with investing in securities before investing.
- Assess the risk-return profile of the investment as well as the liquidity & safety aspects before investing.
- Invest based on sound reasoning, taking into account all publicly available information.
- Secondary Market – Don’ts:
- Given the benefits of trading on the Stock Exchange, it is advisable to avoid off-market transactions.
- Don’t deal with unregistered intermediaries.
- Don’t fall prey to promises of unrealistic returns.
- Don’t invest on the basis of hearsay & rumours; verify before investment.
- Don’t forget to take note of risks involved in the investment.
- If new to share trading, it is strongly recommended that (prospective) investor obtain proper professional investment advice before investing in shares.
Stock Investment Basics
Following are some of the important considerations before investing in the stock market:
Stock Investment Guidelines:
- DIVERSIFY YOUR INVESTMENT: The best way to minimise risk is to diversify your investments across various investment products. If equities are your sole investments, it makes sense to diversify between different sectors and companies. In this way, loss incurred on some investments can be absorbed or compensated by gains made in others.
- UNDERSTAND YOUR RISK PROFILE: As an investor, you must choose between how much risk you can take as all investments carry a certain amount of risk. Consider an investment product not only according to your requirements and how much capital you can invest, but also according to your tolerance of risk. Depending on how ‘risk averse’ or ‘risk-prone’ an investor you are, you may choose an investment accordingly.
- DO YOUR HOMEWORK BEFORE YOU INVEST: To invest well, you must gather and understand all relevant information regarding the investment you are going to make. This includes studying companies’ annual reports, accounts and other statements while keeping abreast of what is happening in the said sector or industry. Consult your investment adviser/ stockbroker to get the latest market information about shares you wish to buy or sell. Do not buy into rumours or be pressured by anyone’s grave but unfounded recommendations before making an investment decision.
- THINK LONG TERM: Investment in shares does not necessarily result in instant yields. Do not invest any money which you may need immediately, since the price of shares can go up and down. Studies have shown that investments properly timed and based on strong fundamentals have been proved to be very profitable for investors in the longer term.
- JUDGEMENT OF TIMING: The aim of investing in stocks and shares is to buy at low and sell at high. Knowing when, however, is the challenge. While it is not easy to time the market, investors should try their best to buy when the upswing has begun, and sell as the downswing starts.
- AVOID HERD MENTALITY: The stock market is driven by two emotions: greed & fear. People are usually caught up in the boom hype and pay beyond the worth of shares. This is the greed that drives bull markets. Don’t allow greed to become your need. In bear markets, people get carried away with the ruling pessimism and are eager to sell their investments believing in the worst rumours. This is the fear that dominates bear markets.
- BEWARE OF SCAMS: Beware of promises of quick profits or sky high returns. Investors must bear in mind that higher the gain on investments, higher is the risk involved. This is the fundamental risk/ reward trade-off.
- KEEP AN EYE ON STOCKS’ PERFORMANCE: Investors must keep an eye on the performance of stocks. They can do so through newspapers, digital media, investment magazines, brokerage firms’ research articles or through other media. A company’s stock performance can take a boost or downturn based on some fundamental changes in the company such as a structural or financial reform. Similiarly, a company can face seasonal or circumstantial boom resulting in better stock performance.
- TAXES & COMMISSIONS: As an investor, you must know the rates of taxes and commissions charged by the Federal Board of Revenue/ Brokerage firm as these affect your costs and hence your returns. There is no prescribed rate of commissions charged and it can vary from firm to firm. Investors must take into consideration the taxes that will be deducted from the trading transactions they will undertake. (For details on current taxes and charges levy, contact your brokerage firm).
Stock Investment Basic Concepts:
- DIVIDEND & DIVIDEND
YIELD: An investor may invest in stocks of a company for its
Dividend is the return paid to shareholders out of the profits of the company. Dividend can be cash dividend or bonus dividend/ shares. Dividends may be paid out by a company more than once a year.
Cash dividend provides for a measure called Dividend Yield. Yield is the measure of cash flow that an investor gets on the amount invested in a security. Dividend Yield is a financial ratio that indicates how much cash dividend a company pays in terms of its share price. Dividend yield is calculated by dividing the cash value of the dividend by the share price. It is defined in percentage.
- EARNING PER SHARE (EPS): This is a ratio calculated by dividing a company’s net profit after tax by the number of shares outstanding. It’s a measure of the strength of the company in terms of its earning capability for each share issued.
- PRICE EARNING RATIO (P/E): This is a ratio calculated by dividing the current share price by its EPS. It’s a measure of valuation and indicates whether the price of a share is realistic and is in-line with its earning. If the share is over-priced, then the ratio will be high and if the share-price is low, the ratio will be low.
- BOOK VALUE OR BREAK-UP VALUE: Book Value per share is calculated by dividing the total equity of a company by its number of shares outstanding. This ratio indicates the asset coverage that each equity share represents in the company.
- CAPITAL GAIN: Capital gain is the selling of shares at a higher price than the purchase price. Multiple such trades can result in multiple capital gain accruing to the investor.
- COMPOUNDING: Compounding is the process in which an asset’s earnings, from either capital gains or profit, are reinvested to generate additional earnings over time. This Investment will generate earnings from initial principal and accumulated earnings from preceding periods.
- DIVIDEND REINVESTMENT: This is the process whereby cash dividends earned from a company are reinvested for stock investment.