How does the stock market work? Who decides the price of stocks?

 "In the short term, the market is a voting machine. But, in the long term, the market is a weighing machine".  -- Ben Graham[1]
Part 1: How the stock market works
Part 2: How does one evaluate Stocks

Part 1: Basics of a Stock Market
History: A long  time ago, humans ran businesses with just their money. The businesses  they ran were small and they grew the businesses only with their own  profits. However, not all businesses can be built with your own money.  What if you wanted to build a new factory that costs more than a million dollars? Banks won't lend money for young companies and your friends won't have that much.

In the 15th-16th century as the Europeans started exploring Asia and Americas, the big explorers felt they needed a lot of money and their kings were not providing them anymore. The wealthy guys demanded a lot of interest. Thus, they felt they need to raise money from a bunch of common people. Thus, in 1602, the Dutch East Indian company became the first company to issue shares of its company in the Amsterdam Stock Exchange and get traded on a continuous basis. 

What is a Stock? Stocks  in a company provide you a share of the company's future profits in  return for the capital invested. For instance, if you buy 1 stock of  Apple now, you will be assured one-billionth of  Apple's profits in the  future (as there are almost a billion such stocks that Apple has issued  now). 

Listing: In  a stock market, 1000s of companies are listed and these companies  (called public companies - as they have given out their shares to common  public) pay a fee to the exchanges, along with a promise to provide all  important info to the markets. In return they get an opportunity to put  their company in the stock market's board & have the ability to get  money from people visiting the market. The first time a company's stock  appears on the stock market's board is called an IPO (Initial Public Offer). 

Brokers: Conceptually,  a stock exchange is similar to eBay. These guys allow companies to  be listed and connect the buyers & sellers. Since millions of people  trade in the market and it is practically impossible for these  exchanges to deal with all the individuals, they have assigned brokers who act between the exchanges and the individuals. 


Part 2: How does one value a stock
Basic Terminology:
We will use a term EPS (Earnings per share) that is exactly as it sounds. It is the profits of the company divided by number of shares. For instance, Apple has $41 billion in profits and about 950 million shares, giving an EPS of about 41000/950 = $44/share. Thus, if you own a share of Apple, you are entitled to 44 bucks of Apple's profits this year. 

Calculating Share price:
To evaluate how much you need to pay for that 1 Apple stock you need to do a simple addition of all the earnings you will get 

         Stock Price = EPS in Year 1 + EPS in Year 2 +... 

Now, you know that a dollar earned 10 years from now is not the same as a dollar earned now. Because, there is an interest rate i involved and money you get in 10 years is less worthy than the money you have now. Thus, you need to adjust that formulae. 

        Stock Price = ((EPS in Year 1)/(1+i))+ (EPS in Year 2/(1+i)^2) +... 

Now, there is a whole bunch of math involved (starting from the compound interest formula) and for the sake of simplicity, I will get you to the final results and reduce the stock price to two cases:

1. In case of a mature company that doesn't grow: 
          Stock price = EPS/Interest rate 

The expected Interest rate is relatively easy to calculate and depends on how risky the company is, how risky the market is and the current long term interest rate of government bonds. For many mature utility companies this interest rate comes to about 10%. Thus, utility companies that doesn't grow much is generally traded at about 10-15 times the EPS. (insert in the formula above). 

The stock prices of these companies are very smooth and change only when there is a change in long term interest rates, the risk profile of the company (can change when hurricanes such as Sandy hits) or when market risk changes (for instance 2008 financial crisis). But on a regular day, not much action here. Let us move to the second category of shares:

2. For a growing company:
           Stock price = EPS of next year / (interest rate - expected growth rate of the company)

Let us use a simple example. If you assume Apple's next year EPS will be $48, the expected interest rate for such a risky company at 15% and an expected annual growth rate at 5%, you will get:

$48/(15%-5%) or $48/10% or $480 as the ideal stock price for the company. Where did I get this magical 5% number?

Getting the growth inputs:
Now, we need to find the growth rate of the company and figure out what the company will earn in the next year, the following year and so on. This is not an exact science and no one has a perfect answer to this question. This is why we need stock markets. Collectively, we all pool our intelligence to figure out the future growth of the company and thereby its current price. 

To do this collective prediction, we constantly get new inputs and project that to future. For instance, if the company management gets hotshot new engineers, then we predict the future will be bright. What are the other news that investors typically use:

1. Periodic financial results of the company that gives us a view into the company;s workings and its financial position
2. Periodic results of similar companies that helps us guess this company;s results. Thus, when Apple sneezes everyone else catches a cold.
3. Changes in the sector. If a new report comes that people are more inclined to using mobile phones, we predict growth of these companies will be high.
4. Changes in the broader market.
5. Changes in the international economy

Market Estimation:
In short, we try to use every possible information to guess the future growth of the company, plug that into our formula and find out the stock price. For instance, if Apple comes out a report saying people are buying less of iPads, we might ding Samsung too as we believe their Galaxy Tabs will sell less too. 

Estimating growth rate is an art rather than a science, and is collectively done by millions of humans in a place called the stock market. Since, we need to constantly adjust the growth rate based on new information, stock prices constantly fluctuate. 

Main advantages of a stock market:
1.  Starting/building a business: The market lets companies get money from a large number of people. That means there are more options to get money to build a business. 

2.  Spreading risk: It lets you spread the risk of a business into a large  number of people. Since, each person is investing only a small portion  of their income in the stock of a particular company, the risk of a single company collapsing doesn't significantly affect investors.

3. Collective estimation of value.
 
Summary: Modern corporations require a lot of capital, which is beyond the reaches of a few individuals. Markets help companies raise money from a large number of  people and together these investors value their company. The theory is  that when a large number of people do their independent valuation, the  company's price comes more closer to its ideal worth. 

 "In the short term, the market is a voting machine. But, in the long term, the market is a weighing machine".  -- Buffett

How does a stock's price fall and rise?

The price is calculated by electronically matching bids and offers for a particular share recorded an electronic limit order book (ELOB). When you place an order to buy a share at a certain price that is called your “bid” and when you place an order to sell your..........blah blah blah blah........

 Getting bored? Going upon your head, huh?

Okay, let's make it easy.

Imagine you bought a pen for 10 bucks. Next day a friend of your offered you to sellit for 15 to him.

Now my question. What's the price of pen?

Absolutely 15. You can encash 15 bucks by selling it.

You rejected his offers hoping that may your other friends bid more than 15.

Next day in school, your friends got a sight of your pen. Again 5 of your friends offered you to sell it for 10, 15, 20, 25, 30 respectively.

Now what's the price?

Yeah, 30. The highest bidder urge to pay 30.

Now again you rejected the offer hoping that tomorrow its price may hike more.

Exactly what you thought happened. You and your pen become popular in school and the highest amount offered by people was 50.

Now your greed acted inside you, so you again rejected the offers hoping for some more appreciation in price.

This time the luck was not with you. A Companion bought more unique pen than your.

This affect the price of your pen a lot. Most of your customer attracted by your companion's pen. Your pen lost 90% of its value and only bunch of people were ready to pay you 5 bucks only.

This is how demand and supply affect the price of a product. And stocks are a product. When investors are optimist and ready to pay higher cash than its current price, price appreciated and in pessimist behaviour price drops.

There was a huge demand of your pen in market and supply was only one (assumed that only one pen of your brand was available in market).

But after your companion's entry, supply increased and demand remain the same, price dropped.

It may also possible that some are ready to pay 15 and some are ready to pay 5 bucks. Although in real world you'll sell your pen to the one who is offering 15 because you know there person but in the world of stock market, you don't know from whom you're are buying stocks or to whom you're selling your stocks. In this case average price is quoted like (in above case) 10 (5+15/2) provided weightage of buyer and seller are equal.

I can also make it complex by saying that only 2 persons are ready to buy your pen at 15 bucks and 13 students for only 5 bucks. In this case weighted average price will be calculated.

But there's no need to go much deeper just keep a small concept in your mind:

·         When demand > supply, price increases.

·         When demand < supply, price decreases.

BSE and NSE have huge algorithm machines which determine the price of stocks on the basis of volume traded. Lakhs of people and crores of shares are traded everyday.

You can get every information regarding volume traded, bidding, offering etc on web (a quick example is illustrated below)

There are also many other reasons for change in price like stock split, merging, demerging, dividend distribution etc.

What? Price changes due to dividend distribution, how is it possible?

Now let's tackle your sub questions in prime question detail.

Ques: If I buy 1 lac shares of the above stock at price 271.55 .Will the stock price rise ?

Yeah, the stock price will rise to 271.55 as you're are the highest bidder among all investors and your high bid will push the stock price up. (Subject to many other reasons, sometime people didn't disclose their bid/offer in public)

But as shown in the image above, offerers are very low so it'll be hard to execute your 1 lakh share bid.

Ques: If I sell 50,000 shares from my demat at price 270.70 ,will the stock price fall ?

Same reason as above, you're the lowest offerer among all others, so it'll turn the price down. (Subject to many other reason, it's just a basic reason)

Ques: What does "Best 5 Bids/Offers table" show?

I suppose this should be your first question.

·         Best 5 bids - next best nearest price at which people are ready to buy stock.

·         Best 5 offers - next best nearest price at which people are ready to sell stock.

Ques: If only 10 Qty. at price 271.55 if someone place buy for 20 quantity. what will happen ?

As per my knowledge only 10 stocks will be traded. I can't clearly say about it as it had never happened with me. If anybody know about it then notify in comments.

Some time it happens that you have put a buy or sell limit price to Rs 100 and then share go to 100 and come back again to lower value but your trade does not get executed.

So why this happens? Because of 2 reasons:

·         There was no one for selling at Rs 100 (very rare case)

·         Enough quantity was not available at Rs 100, for example 500 quantities are available at Rs 100 but before you, someone else order was pending so his order will get executed first than yours.

Some time it happens that you have put a buy or sell limit price to Rs 100 and then share go to 100 and come back again to lower value but your trade does not get executed.

So why this happens? Because of 2 reasons:

·         There was no one for selling at Rs 100 (very rare case)

·         Enough quantity was not available at Rs 100, for example 500 quantities are available at Rs 100 but before you, someone else order was pending so his order will get executed first than yours.

Best dividend paying stocks in India

Every successful investor wants stable returns from their portfolio.So we are here listing top dividend-paying stocks for your convenience.Though there are a lot of companies which pay a good amount of dividend, but consistency is very important.We will list the companies which had paid high dividends consistently for a long period of time and they are likely to continue paying dividends at the same rate.

Dividends provide passive income to investors.They can be more trusted during uncertain times such as market crashes because they are mostly held tight by investors.It is a very good idea to buy top dividend paying stocks during market crashes as they provide a good entry point.

Warren Buffet is known to invest in the best dividend paying companies.As we all know the saying ‘’slow and steady wins the race’’,this is the case with stocks also.Every successful investor builds their wealth over decades.Reinvesting the dividends again is very important.This keeps you ahead of inflation.

It also acts as a good vehicle for those who want regular income from their investments.Before choosing companies for a dividend ,it should be thoroughly researched.There are companies which pay high amounts of dividends inconsistently.The consistency of the company paying a dividend should be checked first.We should look for companies which are providing good dividend yield consistently.This dividend yield should be increasing slightly on a yearly basis.If there is an abrupt increase in dividend yield, it is a word of caution. Because such high dividend yield may not be sustainable for the company.

Another word of caution is that one should not invest just by seeing the dividend history.Fundamentals of the company should be checked beforehand.Always check for debt-to-equity ratio which should not be more than 2.Ideally the debt to equity ratio should be less than 1.

For y convenience we are listing here the top dividend paying stocks which have provided a consistent amount of dividend for over a decade and hopefully they will keep providing the same in the future.

 first choice among top dividend paying stocks is:

1.Page Industries-We all know the brand Jockey.They produce quality inner-wear and are unbeatable in quality.They also produce swimwear known by the brand name speedo. The company has provided not only consistent returns to it’s investors but also has provided good amounts of the dividend.The company has provided 48% of it’s net profit to it’s investors since 2007.It has also appreciated in price since 2007 giving an annual compound growth of 61%.

 second choice:

2.P&G Hygiene-They produces well-known house hold products such as Vicks, Ariel, Tide, Whisper, Olay, Gillette, Pampers, Pantene,Oral-B and Head and shoulders. In the past 10 years, this company has given 40% of it’s net income to it’s investors as dividends which is very lucrative.Though the growth of this company is not that fast but because of it’s strong dividend history, the price of the stock has appreciated at a rate of 30% annually.For a long term investor, it is a good bet.

 third choice:

3.Coal India Limited-Coal India has provided a consistent amount of dividend in last 5 years.The average dividend yield for last 5 years was 5.26%.This could be thought as a good investment.

 forth choice among top dividend paying stock is:

4.Asian Paints-Asian paints which are well-known brand.It is the industry leader in its sector.It has given 42% of its net income over a period of 10 years to its investors.The company is expected to pay the same amount of dividend in future.

 fifth choice:

5.NHPC-NHPC is Indian hydropower generation company.It has provided an average dividend yield of 7.89% in last 5 years.It is expected to deliver the same amount of dividend in future.

Guide To Finding Multibagger Stocks

Multibagger Stocks Meaning

Peter Lynch, the highly respected manager of Fidelity Investments Mutual Fund, coined the word “multibagger stock” in his books One Up on Wall Street and Beating the Street.

The term became very popular amongst investors because Peter Lynch gave practical examples of how companies that we use in the daily life like McDonalds, Dunkin Donut, Walt Disney, Ford Motor Co etc are great investment opportunities and give huge gains to shareholders.

The reference by Peter Lynch was to stocks which can give a return which is several times the investment made in them.

So, a stock which gives a gain of 200% and returns 300% of the investment becomes a 3-bagger. A stock which gives 10 times the investment is called a 10-bagger.

Meaning Of 100-Baggers

The concept of 100-baggers was made popular by Thomas Phelps in his book “100 to 1 In The Stock Market”.

Thomas Phelps referred to stocks which the potential to give 100x the investment made in them. Phelps gave several examples of such stocks and also gave a detailed explanation on the process that should be adopted by investors to find such stocks.

Penny Stocks, Micro-Cap & Small-Cap stocks

Generally, multibagger stocks are to be found in penny, micro and small-cap stocks. The reason for this is simple. These stocks have a smaller market capitalisation and find it easier to double and triple their net worth in a short while.

For, example a stock with a market capitalisation of only Rs. 100 crore can easily grow to a market capitalisation of Rs. 500 crore and give investors a 500% return.

In contrast, large-cap companies will find it very difficult, if not impossible to give multibagger returns to their shareholders.

Examples of multibagger stocks in India

There are several stocks in India which have given 10x and even 100x returns. Most of these stocks belong to the penny and small-cap space.

Caplin Point Laboratories is one example of a stock which has given a 10x return in a short period of time. Caplin Point manufactures pharmaceutical products and exports them to Venezuala and other Latin American countries.

Another example of a multibagger stock is Uniply Industries. The stock has attracted marquee investors like Radhakishan Damani, Ramesh Damani and Vallabh Bhanshali and has given a return of 1400%.

There are several other examples of stocks which have become multibagger and created huge wealth for investors. Stocks like Ajanta Pharma, Alembic Pharma, Mangalam Drugs, Intrasoft Technologies, Lanco Industries (Srikalahasthi Pipes), Shreyas Shipping, Page Industries, Hawkins Cooker, PI Industries etc are examples of such stocks.

How To Find Multibagger Stocks

Generally speaking, one has to hunt for such stocks in the penny, micro and small-cap space. Such stocks have a low market capitalisation which makes it easier for them to grow exponentially.

Moat

One has to find stocks that enjoy a moat from the competition. The moat can be in the form of a technological advantage or a marketing advantage. Basically, the company must be able to fend off competitors from laying stake to the market.

High RoE Companies

It is a common feature of penny and small-cap stocks which are growing fast that they will enjoy high rates of RoE. The RoE must be in excess of 20% to be attractive. The high RoE shows that the Company is growing in a profitable manner and that the growth is not coming at the cost of profits.

It is elementary that if a company does not make profit and instead suffers a loss, it will soon run out of capital and will have to go for liquidation and be wound up.

In fact, several companies in the e-commerce space have chased high growth at the cost of profits. Such a strategy is not sustainable in the long run and has resulted in the closure of these companies.

Examples of such companies are Local Banya, Tiny Owl, Grofers, Hola Chef etc.

Characteristics of multibagger stocks

The following are the salient features that all potential multibagger stocks display

(i) The Company offers a product or a service that is unique or innovative and for which there is a lot of demand and not much competition;

(ii) The size of the opportunity should be huge in relation to the size of the Company;

(iii) The Company should enjoy high profitability which will be reflected in the RoE levels;

(iv) The promoters should be highly committed and able to steer the Company to new heights through hard work and perseverance;

(v) The promoters must have the honesty and integrity to want to share the gains of the Company with the shareholders;

(vi) The Company should have low debt or be debt-free.

Humanity

Real Humanity:

Yes, seen a real humanity. 

Due to doctor appointment I was travelling to Chennai from Bangalore. All knows due to ongoing bangalore issues. No straight bus to bangalore. Took the bus to Attible (Karnataka Border), and crossed the border by walk. Lot of police in border both sides. 

It's really like entering into another country.  I have seen these kind of border crossing by walk in Indo-Nepal Border. So somehow, reached bangalore next day and walking from Nandanam Arts College to R.A. Puram (about 2 Kms, as no straight bus). 

Stopped into one Sugar Cane Juice shop, the shopkeeper was preparing juice in the machine. 

Suddenly heard a sound. When looking back, a middle aged man, fallen into road from Bike. But, his bad luck he fallen into road after hitting road divider. He really got hit in his head by divider and started bleeding. He got fits as well. All over his body is shaking. He was riding KA Scooter. 

So, people started gathering and helping him with Steel to stop his fits and one person teared his Dhoti to cover his bleeding wound. 

Sugar cane shop keeper stopped the squeezing machine, and started praying GOD.  He completely praying god for accident person.

Meantime, police from near by signal rushed and informed ambulance. At least his fits stopped, only bleeding from his head. Finally, ambulance reached spot he taken into hospital.

All over this incident, I have really seen humanity with almost everyone.

I could remember one incident, two years back when I was sitting behind my friend. One old man crossed road without looking road. My friend tried to stop the bike. But finally fallen into road. I got bleeding in forehead. No one in the road came near by. I was simply walking into road looking for hospital with bleeding all over the shirt.