Basics of Share Market Operations- By Mr.

Sachin Lele

1. Share market is very similar to any other business where the demand and
supply decides the rate for a particular commodity or for a service. Two
important human feelings (Fear and Greed) create demand and supply for any
business in this world and share market is not an exception to it.

2. Everybody of us purchase insurance policy to get the financial security

(fear about the death) while, we also make some investments in land or gold to
get profit from it (greed for money). Same way in share market, a person decides
to buy a particular share at Rs. 100 as he intends to make a profit out of it by
selling that share at Rs. 120 in near future (Again the greed). When the market
goes down, a person tires to sell the shares that he is holding as he fears about
suffering losses (fear).

3. Share market is a place where shares of different companies are traded.

So, without knowing the movements in a particular share, it is difficult to
understand how market works. After all share market is a collection of all shares
traded.

4. To start with, let’s take a real life example. Mr. X and Mr. Y started a
hotel business by investing Rs. 15 lakhs each. They decided the face value of
every share would be Rs. 1,000. That means, both of them hold 1,500 shares
each. This investment is known as the seed capital of the business. They also got
a loan of Rs. 10 lakh from ICICI Bank. Now, total investment in business
becomes Rs. 40 lakh.

5. For hotel furniture and other purposes, they spend about Rs. 25 lakhs and
purchased raw material of Rs. 5 lakh. After carrying out operations for one year,
their Profit and Loss A/c looks like,

Exhibit 1: P & L account draft

Profit & Loss A/c as on 31.3. 2009
Particulars Amount Meaning
Net Revenue 12,00,000 Net revenue is your total sales
Operating Exp. 9,00,000 All expenses related to business
Net Profit 3,00,000 Pure profit made after paying all
expenses
No. of Shares 3,000 (Mr. X-1,500 shares, Mr. Y- 1,500
shares
EPS 100 EPS is the profit available to each

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 share

6. EPS = Net Profit/ Total No. of shares. The concept of EPS is very
important in share market. It indicates the amount of profit, owned by each share.
Share price movements are mainly dependent upon the increase or decline in
EPS.

7. Now, the firm wants to expand the business but don’t have enough funds.
So, they decided to enter the share market with IPO (Initial Public Offering). Any
firm that wants to enter the share market through IPO route has to file a Red
Hearing Prospectus with SEBI, the controlling body of Indian share market.

8. This prospectus is nothing but an offer made to interested investors,

inviting them to purchase company’s shares. Some of the other factors included
in this documents are as follows,

• Information about nature of company’s business (what is the business, how it

operates, who are the owners, how much investment they have made in this
business and which is the prime market in which the company operates)

• Financial position of the company (this includes P & L account and Balance
sheet of the company for last five years period). This gives a rough idea about
how the financial position and strengths of this firm.

• Future expansion plans and details about proposed investment plans for which
the firm wants to raise the money from new shareholders. In simple words, it is
an indication to interested shareholders about where his/her money will be
invested by the company.

• Risks associated with the business of the company. These risks may be specific
to the company (legal cases pending) or to the industry (proposed changes in
government rules)

• IPO Grading – for every company offering IPO, it is mandatory to have IPO
grading. This grading is done by credit rating agencies such as CARE, CRISIL,
and ICRA. The grading gives 1 to 5 rating to IPO after considering company’s
financial strength and its ability to earn profit in near future.

9. In an IPO process, an investor is given a price band, in which he has to

apply for the IPO. For Ex. NTPC IPO’s price band was Rs. 30-36. That means,

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 an investor can apply for the IPO at per share price between Rs. 30 to Rs. 36. Rs.
30 is lower price band while, Rs. 36 is upper price band.

10. Now, let’s consider our previous example of hotel business. This
company has 3,000 shares. It plans to offer another 3,000 shares to public. So the
total issue size stands at 3,000 shares. Now, for deciding price band of this issue,
a concept called as PE ratio comes into picture.

11. What is a PE ratio?

Price to Earning Ratio (PE) = Market Price/ EPS

12. Price to earnings ratio indicates the value given by the market to a single
share in company for every rupee earned by that share (EPS). If a share is
currently trading at Rs. 100 and its EPS is Rs. 20, then the PE ratio stands at 5. In
simple words, the market is ready to offer 5 times value for every rupee earned
by an individual share (EPS).

13. When a new company comes with IPO, its P/E ratio is decided after
comparing P/E ratio of its competitors, which are already listed in the market.
Example- Adani Power offered IPO. Now, while deciding its PE ratio, the
existing P/E ratio of its competitors such as NTPC, Reliance Power is compared
with.

14. P/E Ratio is dependent on following factors.

• Company’s market position (market share, customer base, earning capacity)

• Industry attractiveness (whether that industry is growing or dyeing)
• Economic condition (country’s GDP growth, overall economic conditions)
• Future expansion plans of the company and an expected change in
company’s earning capacity.

15. Let’s go back to our example. Our company has 3,000 shares and wants
to offer 3,000 new shares to public. If our competitor firms are trading at P/E of
17, 15 and 12 then P/E for our per share offered has to be somewhere around it.
Let’s take this range as 12-17. That means, our share price will be based on P/E
range of 12-17. Now the pricing of shares is as follows,

Face Value per share = Rs. 1,000 Total shares to be newly issued – 3,000
shares
EPS = 100 (Pls. see exhibit no.1). P/E range decided = 12-17

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 Lower price = 12* 100 = 1200 (Price = P/E * EPS) Higher price = (17*100=
1,700)
Price Band for the issue = 1,200 to 1,700.

16. Now, with a price band of Rs. 1,200 to 1,700, our company will offer
3,000 new shares to public. The investors will apply for this issue indicating price
of their choice (with in band). Suppose for 3,000 shares we get 12,000
applications then the highest bids for the issue (Rs. 1,700) becomes the offer
price for these shares. This is called Book Building process where the investors
collectively decide the offer price.

17. Now, suppose the offer price for our IPO is set at Rs. 1,700, the company
will raise,

1,700 * 3,000 = 51 lakh

18. Prior to issue, the company’s ownership was divided between X and Y in
the ratio of 1:1, as both of them have invested Rs. 15 lakh each. But now,
company’s equity capital has increased from 3,000 shares to 6,000 shares.
Naturally, the new ratio is calculated as

Capital Structure prior to issue Capital Structure post issue

Shareholder Shares Held Equity Shareholder Shares Held Equity
share share
Mr. X 1,500 50% Mr. X 1,500 25%
Mr. Y 1,500 50% Mr. Y 1,500 25%
Public 3,000 50%
Total 3,000 100% Total 6,000 100%

Due to this IPO process, X & Y’s equity share or stake in the company has come
down from 50% to 25% each. The P/E ratio applied on IPO shares indicated the
price paid for goodwill of the business \created by the original promoters of the
company.

How a share price goes up or down in day to day market?

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 19.In day to day market, demand and supply for a particular share decides it price
while, any news which will increase or decrease the net profit or long term
position of the company will encourage the investors to buy or sell the shares.
Let’s take an example.

Tata Steel increases the price of its steel product by 5%. Tata Steel supplies steel to
Maruti Suzuki for making passenger cars. Gati transport, another listed company
transports those steel parts from Tata Steel’s Jamshedpur plant to Maruti’s
production center at Gurgaon, Haryana. Now, this news will have different impact
on all three companies involved.

Company Impact Likely Share Movement

Tata Steel Profit will increase due to higher Share will rise
revenue
Maruti Profit will go down due to rise in Share will fall
raw material cost.
Gati Profit will rise if Tata Steel allows it Depends on Tata Steel’s
to charge higher transportation decision.
charges

When a company’s net profit rises, naturally the EPS also goes up, which results
into an upward movement in that share. Now, on this news, an investor would like
to purchase Tata Steel’s share if he believes that, the share price will rise further
and he will get the profit. Same way, an investor in Maruti’s shares thinks that, the
steel price hike may impact Maruti’s profitability and EPS. Then if he believes
that, the share price will fall in near future, he gives a sell order on Maruti.

20. This way, if the demand for a particular share exceeds the supply (if buyers are
more than sellers) the share will rise. If it is reverse, the share will fall. When
Satyam fraud was came in public, every shareholder of this company (including
directors) tried to sell their shares. But even when the price was falling, nobody
was interested in buying those shares. Supply became 10 times than demand
and the share declined 65% in one day.

21. Types of news or events (stock specific and general)which may impact share
prices,

• Mergers and acquisitions

• Any major contract received by the company
• Any government decision which may have an impact on business

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 • Any increase in company’s cost structure.
• Any other economic development

22.Then how BSE Sensex and Nifty goes up/down?

BSE Sensex and Nifty are called as Indices of the share market. Sensex is a list
of 30 top companies in India while, Nifty includes 50 companies.

Let’s take BSE Sensex first. When the Sensex started, on the first day, top 30
companies were picked up.

Name of Share price (starting

company date)
Reliance 500
Industries
Tata Steel 340
ONGC 200
ICICI Bank 150
SBI 400
Infosys 50
Total 1740

It means, for purchasing one share of all companies, I need to invest 1740 Rs on day
1. This 1740 value was considered as 1,000 (as a benchmark). Now suppose, next day,
some shares increased and some decreased. Total value of 1,740 becomes 1,800. Now
I need to invest 60 Rs. more to buy all those shares. That means, the market has gone
up by

(1800-1740)/1740 = 60/1760 = 3.4%

Now the index value will rise from 1,000 to 1,034. (Considering 3.4% rise in market).
This way, the index value is being calculated everyday. The BSE Sensex started its
journey at 1,000 and has reached to today’s level of 15,000. It means, the market has
gone up by almost 15 times in last 20-25 years.

Does and don’ts in share market

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 1. Don’t fall into trap of advertisement which offers 30 days training and assures
Rs. 1 lakh income every month. If it is that simple, why these guys are taking classes
and not making money themselves? People always talk about profit, remain silent
about losses, they have incurred.

2. Never buy shares on ‘Tips’. Without knowledge about that company, don’t invest
in it. You should read broker reports and refers to tips given by experts on CNBC
but don’t rely on them blindly. Apply your logic.

3. It is not necessary to trade everyday, but mandatory to have a close watch on

happenings in market. If you are a new investor, don’t start intra day in first year,
you are bound to lose money.

4. Please see the website of the company, you are investing in. See board of
directors, company’s business and financials, major news (all of this is available on
www.moneycontrol.com)

5. Important sources of information

• Economic times- it is a Bible for you. The internet edition is

available on its website freely.
• Loksatta- Artha Vruttant – Every Monday
• CNBC Aawaz, - helps to understand share market, being in Hindi.
• Money control- the best website ever made for investors
• NSE, BSE Websites- a lot of information about daily happenings in the market

Important Terms used in share market

1. Types of investors – Although every investor does a basic role of investing in

shares and mutual funds, the origin of these investor and volume of shared
traded by them differs. Followings are some of the types of investors.

• Retail or individual investors – People like you and me, which invests in
shares, generally in small quantity are called as retail investors. These people
make a very small impact on price performance of any share as the quantity
demand or sold by them is very low.

• HNIs (High Networth Individuals) - People who invest more than 1 lakh Rs.
in an IPO are called as HNIs. This doesn’t mean that, every individual

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 investing more than 1 lakh becomes HNI. For this status, your financial
position and credit worthiness needs to be very strong.

• FIIs- Any individual or a company investing in Indian share market but who
is not a resident of India and not listed as a business entity in India. This FII
category includes common investors, mutual funds, pension funds, financial
institutions also. Every FII has to register with SEBI prior to investing in
India companies. Even SEBI has formed some restrictions on FIIs indicating
up to how much % they can invest in a single company.

• DII (Domestic Institutional Investors) - Major financial companies, mutual

funds, insurance companies and fund houses based in India are called as
DIIs. Generally these players purchase and sell shares in crores and not in
thousands. LIC, Reliance Mutual funds, ICICI Pru mutual fund are some of
the examples of players in this category.

2. Governing Bodies in India- India has a very good structure of governing bodies
on all the important financial sectors. These bodies controls and develops the
particular sector that they govern. Another important function or responsibility
of these bodies is to protect the interest of the investors or the customers.
Followings are some of the bodies under this category.

• SEBI – Securities Exchange Board of India- It is the governing body of all

capital market transactions in India (Equity, debt and other commercial papers).
Followings are some of the functions of SEBI
1. Conducting any legal inquiry or taking any action which is necessary
to protect investor’s interest.
2. Regulating business of stock exchanges and other securities market
3. Controlling activities of custodians, depositories, venture capitals
4. Prohibiting unfair trade practices
5. regulating acquisition and mergers issues
6. increasing customer awareness

• RBI – Reserve Bank of India has the supreme body in Indian banking
industry. It is on of the most powerful bodies in India. Followings are some of the
functions of RBI
1. Maintaining smooth and adequate flow of credit to various sectors
with the help of monetary policy.
2. Regulating financial sectors and India’s financial system.
3. Managing flow of foreign exchange in the country
4. Issue of currency (notes and coins)

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5. Other developmental functions in the economy.

• IRDA – Insurance Regulatory and Development Authority- It is the

controlling body of all transactions in India’s insurance sector. Followings are some of
its functions
1. Issue, renew, modify or to cancel the license issued to Indian insurance
companies
2. Protect interest of insurance policy holders
3. Specifying code of conduct for surveyors, or to provide guidance on
disputes.
4. Regulating investment made by insurance schemes in various financial
instruments.
5. Exercising any legal action, required by the circumstances.

• AMFI (Association of Mutual Funds in India) is not a governing body but a

group of all mutual funds in India. This site gives information about Mutual
funds industry, assets under management of all mutual funds and other
related information.

3. Terms related to trading

• Brokerage- an investor has to purchase or sell the shares through any broker
(Sharekhan, Motilal Oswal, and Kotak Securities). These brokers charge
some fees to you for this purpose. This fee is called as brokerage. The
brokerage is calculated as a % of amount purchased or sold.

• Intraday – when a share in purchased and sold in a single day, it is called as

intraday trading. It is also known as day trading. For this, you need to keep a
watch on ups and down in the market for almost every minute. The profit
margin in this trade is very low. Same way, the brokerage rate is also low.
So, you need to buy and sell shares worth Rs. 1 lakh everyday, so that you
can make a profit of Rs.1000 (considering 1% pure margin). Additionally
there is no guarantee of this profit. Generally a new investor should not do
intra day at least during first 1 year.

• Delivery- When we purchase a share and don’t sell it on that day, it is called
as taking delivery of shares. Once you take the delivery, the shares are
credited to your account with in next two working days. For. Ex. If you
purchase 10 shares on Monday and don’t sell it till Monday evening (3.30
pm), you need to take delivery of those shares. By Wednesday evening,
these shares will be credited to your account and the money will be debited
from your account.

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 • Short sell – In case of intra day trade, the buying quantity should be equal to
selling quantity. Suppose, Reliance Industries share increased 6% and
trading on 2,200 at 12.30 pm and if you feel that, this share will decline from
this point and at the end it should settle down with 3% gain only. You can
sell 100 shares of Reliance at 2,200 rate, even though you don’t have 100
shares in your account. This is called as short selling.
• But you must buy 100 shares before 3.30 (closing of the day) otherwise you
need to pay heavy penalty. Suppose at 3.25, Reliance is trading at 2,250,
then you need to buy at that rate and suffer a loss of 50*100= 5,000. Don’t
do short sell till the movement you get a good knowledge and good
experience in normal trading.

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