Home Finance 11 Basic Share Market Terms | Must know before Investing

11 Basic Share Market Terms | Must know before Investing

Before investing in the share market, you must have the proper knowledge of it. So here in this blog, I would explain to you the most basic and used terms which you will come across frequently while investing in the share market

In this blog I will explain you the following share market terms:

  1. Stock market index
    1. Sensex
  2. Bear market
  3. Bull market
  4. Market value
  5. Face value
  6. Book value
  7.  Market capitalization
  8.  p/e ratio
  9.  p/b ratio
  10.  Dividend
  11. Stock split
  12. Rights Issue
  13. Conclusion
  14. Q&A

Stock Market Index

You must have heard of Sensex and Nifty, these are some of the share market indices. In this section I would discuss the stock market index and why do we need them?

But if I ask you about “How the share market is moving today?”, how would you answer that?

There are 5000 companies listed on BSE and 2500 companies listed on NSE. It would be quite difficult for you to check the share price movement of each company, whether they are going up or down for the day, and give a detailed answer.

Instead, you would just check a few important companies across key industries. If the majority of the share prices are moving up, then you would say the market is up, but if the majority are moving down, you would say markets are down.

So, basically the stock market index is an index that helps investors compare current price level with the past price of the share and calculate market performance.

The two main market indices in India are:

Sensex

Sensex is also called as the S&P Sensex BSE index. It comprises of 30 of the largest stocks on BSE by market capitalization. (I would talk about market capitalization later in the blog, till then just imagine they are the biggest companies on BSE).

sensex 5 year chart
A Previous 5-year chart of Sensex

Nifty

It is also known as Nifty 50. It comprises of 50 of the largest stock on NSE by market capitalization.

A previous 5 year Nifty chart
A previous 5 year Nifty chart

Other than the above indices, there are also some other market indices grouped by specific market sectors. Some of them are:

  • Nifty auto index: It is designed to reflect the performance of the automobile sector. It comprises of 15 stocks that are listed o NSE.
  • Nifty bank index: It comprises of the large capitalized Indian banking stocks. It comprises of 12 stocks listed on NSE.

Similarly, there are other indices also based on sectors such as nifty FMCG index, nifty IT index, nifty pharma index, etc. Also, there are indices based on sectors of stocks listed on BSE, these are BSE PSU, BSE healthcare, BSE power, etc.

Furthermore, Check out all the market index present on NSE and BSE.

Bull Market

It is a market trend where the price of stocks rises- usually months or years. It can also be defined as a situation in which stock price rises by 20%, usually after a drop of 20% and before a second 20% drop. 

A bull statue on Wall Street signifying Bull Market
A bull statue on Wall Street signifying Bull Market

The bull market generally takes place when the economy is strengthening or is already strong. Investors are more willing to take part in the stock market in order to gain profit as investor confidence tends to climb throughout a bull market period.

Bear Market

It is the opposite of the bull market where market experiences prolonged price declines.

Bull Market is usually described as a condition in which prices falls 20% or more from recent highs, due to negative investor sentiment amid a weak or slowing economy.

In March 2020, global markets including the Indian market entered a sudden bear market due to the widespread corona-virus pandemic.

a chart going down signifying bear market

Investors can make a profit in a bear market by short selling, which means selling your shares when this trend of the bear market starts and buying them again at lower prices when the market goes down, but it is a risky trade and can cause losses if the things do not work as expected.

Watch this video to learn more about short selling

Market Value

The market value of a share is the price at which you buy or sell shares in the share market. The market value of a share changes from time to time.

It shows the market value of some shares
On the right is the market value of some shares on 21 May, 2020.

However, in the above picture you can see that, below the market price is a number written with a + in some and – in some cases and along with it is written a percentage in the bracket. It is the rise or decrease in price as compared to the previous trading day.

Face Value

It is defined as the original cost of stock as listed on the share certificate. However, you might be wondering “what is a share certificate?”

Nowadays, stock exists in dematerialized or electronic form in your Demat account but in the past, the shares were in the form of a physical certificate with the buyer name. On it the face value of share also used to be present.  

The face value of a share remains constant throughout but changes only at the time of stock split.

Additionally, let’s try to understand “what actually is face value of a share?” with an example:

For example, a company ABC at its initial phase wants to raise funds or capital of Rs20 lakhs, from their promoters or founders. So, they distributed 4 lakh shares among the promoters on the basis of their investment at Rs5/share. Therefore, face value is this initial value of the share that a company decides at the time of its starting.    

 Book Value

In brief, the book value of a share indicates the amount that a company could get per share by selling all the assets of the company and paying off all the liabilities divided by the number of outstanding shares.

So, Book value of a share =

   Tangible assets – liabilities / number of outstanding shares     

Book value of a share changes when assets, liabilities, or the number of outstanding shares changes.

The stock is undervalued if the book value is smaller than the market value and is overvalued if the book value is greater than the market value.

Market Capitalization

Market capitalization is the actual value of a company that is being traded on the share market. Accordingly, it can be found by multiplying the total number of shares outstanding with the price of a share.

P/E Ratio

It is very important before investing in a stock to calculate its right value and determine whether it is overvalued or undervalued. It is calculated using the p/e ratio.

p/e ratio is defined as price per share to earnings per share.

p/e ratio = price per share/earnings per share (EPS).   

For example, there are two companies A and B belonging to the same industry, their p/e ratios are 20 and 40 respectively and the average p/e ratio of the industry is 30. Then you will here say that company A is undervalued and buying its stock will be beneficial as the company will grow to the average p/e ratio of its industry and you will gain profit. But that is not correct, you must look at least the previous 3 years of p/e ratio of a company before coming to a conclusion.

To clarify, I have given below the p/e ratio of company A and B of previous three years:

COMPANY-A

 Yr. 1Yr. 2Yr.3
EPS101112
Price100110120
P/E101010
COMPANY – B
 Yr.1Yr.2Yr.3
EPS102040
Price1505001600
P/E152540

Here you can clearly see company B p/e ratio is increasing year on year and investing in it is more beneficial than company A.

P/B Ratio

It is a ratio of a company’s market value of a share to its book value.

p/b ratio = market value of a share/book value of a share    
Watch this video to understand more about p/b ratio

Dividend

Dividend is the distribution of profits made by the company during the year in cash to its shareholders.

It is expressed as a percentage of the face value of a stock. For example company A decides to give dividends to shareholders then it will give it in the form of a percentage of face value like 300% of face value.

But, here you may be wondering that it will be such a huge amount. But I tell you it is the face value, not the market value. Additionally, the face value of most of the Indian publically listed companies is Rs.5. So, here in this case dividend will be Rs15/share by taking face value of the company as Rs5.

However, it is not essential for a company to pay dividends. As a result, some of the companies do not pay dividends, they think they can use that cash to increase their company’s growth. Also, there are chances that a company makes losses in a year, so in this case it will be quite difficult for them to pay dividends.  

stock dividend

Stock Split

When the market value of a share increases very much, many investors might not be able to invest in it. So to solve this problem, and increase investor participation, the company split the stock.

For example, suppose the stock’s face value is Rs.8 and market value is Rs5,000 and there is a 1:2 stock-split, then the face value will change to Rs.4 and if you own 1 share before the split, after the split you would be having 2 shares.

Also, the market value of the share will reduce to half, In our example, it will be now Rs.2,500 without any change in the market capitalization of a company. 

Rights Issue

In short, the Rights issue is the offer of providing additional shares of the company to its existing shareholders.

However, the price of the share to be issued is decided by the company. Also, the price can be less than the current market price of shares.

But, it is the choice of shareholder if that wants to go for the rights issue or not.

For example, a company decided to give the rights issue of 1:2. Thus, it means that the existing shareholder of this company can buy 1 share for the 2 shares they have of this company. But, it is the choice of a shareholder if they want to buy or not, it is not compulsory.

Conclusion

To summarize, in this blog we learn about basic stock market terms like dividend, stock split, bull and bear market, market value, face value, the book value of a share, financial ratios like p/e ratio, p/b ratio.

After reading this blog you must be clear about all the important terms that you will see in the share market and they will also help you in investing.

But this is not enough knowledge that you need before investing in the share market. You must learn about Technical and fundamental analysis before investing. Furthermore, you can read my blog on Technical analysis and Fundamental analysis to learn about them.

To sum up, if you are interested in reading books, you can read the best 10 books on stock market recommended in this blog.

Q&A

Q1. Can Dividend yield be negative?
Ans. No, the dividend yield cannot be negative. Therefore, it is a positive term.

Q2. How Dividend is calculated?
Ans. Dividend is calculated by using face value.

Q3. What Sensex mean?
Ans. It is a stock market index.

I am a student currently pursuing B-tech in electrical engineering from Delhi Technological university.

Tushar Gupta
I am a student currently pursuing B-tech in electrical engineering from Delhi Technological university.
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