how do companies cook books

How Do Companies Cook The Books?

Financial statements are one of the widely relied upon tool to analyze a business. However, there are many ways in which companies cook their books and create a false impression of the company’s financial health using accounting gimmicks and financial shenanigans. In this post, we are going to look at how companies cook books and how you can identify such financial shenanigans using accounting red flags.

If you look into the past, you will find that cooking books is not a recent phenomenon, but has existed for a long time. We all know one or the other company which has resorted to accounting gimmicks to dupe investors into believing that the company is doing well. Each market has its own share of such “gutsy” companies which, instead of genuinely improving the business, resorts to cooking books to show improved performance.

Why Companies Cook Books?

How Do Companies Cook The Books cover

The question is, why do companies need to cook books? Why does the management resort to such gimmicks instead of being honest with their investors? Well, cooking books is not just about looking great on paper, some of the common reasons why companies do so are explained below:

1. To meet or exceed market expectations:

Let’s honestly admit one thing, the world is a fiercely competitive place and everyone wants to be on the top of their game. Miss the mark by a few points, and the company’s stock price gets hammered badly by the market.

With ever intensifying competition and “Go big or go home” thinking, the management of every company is pressed to either beat or at least meet the growth expected by the market.

With such mounting pressure to perform, companies that fail to deliver as per expectations, often get involved in cooking books and create a false image of healthy growth.

2. Vested Interests of the Management: 

The second reason why companies cook books is because the management has its own vested interest behind it. Nowadays, many companies offer share price linked incentives to their managers.

Such schemes are offered to align the interests of the shareholders to that of management so that both can benefit from the good performance of the business.

Incentives linked to the share price motivates the managers of the company to work harder and deliver a good performance.

When the times are tough, and business struggles to perform, top managers, driven by greed of incentives and fear of being penalized for poor performance start window dressing the accounts to paint a rosy picture of company’s performance.

3. To show a consistent growth rate by under-reporting current spurt of growth:

This is something that does not happen pretty often, but there are times when companies do under-report their financial performance. Why? Let me explain.

Investors love companies with strong consistent performance and growth, and company managers know this very well. There are some companies that have a seasonal business, where they perform well when times are favorable and do poorly otherwise.

Such companies during good times minimize the current earnings by under-reporting the revenues or by inflating current period expenses by postponing good financial information for the future period when the company is more likely to underperform.

This again creates an illusion for investors that the company has performed well compared to its peers even during tough times.

As a result, such companies command higher valuations which they do not actually deserve.

How Companies cook books?

Management of the companies may have different reasons behind cooking books, but the way it is achieved has hardly ever changed.

The only way management of the companies can manipulate books is by concealing information, in other words, by hiding it in places where it is difficult to detect easily.

So how do companies cook books? Well, as I said earlier, it’s all about hiding crucial information about the company within the financial statements so that they are not easily traceable.

There are only three ways a company can manipulate earnings, by manipulating earnings, profit, and cash flow.

1. Earnings Manipulation:

Earnings manipulation occurs when companies try to inflate (or in some cases, hide) their earnings such as revenue. There are two ways companies manipulate their earnings.

— Recording Revenue prematurely: Booking revenues in advance is one of the most commonly used financial shenanigan by the companies. It includes booking revenues even before the goods are sold or a project is completed.

An example of such premature recording of revenue was seen in Sobha Developers in 2008-09. In Q1 of 2008-09, Sobha Developers decided to recognize the revenue earlier during a project cycle. This led to a 20% jump in the company’s profits before tax.

— Recording income from investment as revenue: The second most common way to manipulating earnings is by recording revenue from other sources as operating revenue.

If proceeds from the sale of an asset (such as land, building, plant, and machinery) or income from an investment (such as maturity of a bond or proceeds from the sale of shares) is recorded as revenue, it will boost the total revenue of the company.

Since these are a one-time phenomenon, and cannot be repeated in the future, recording such one-time sources of revenue gives a false impression of improved financial performance.

earnings manipulation

2. Profit Manipulation:

Profit is considered to be the blood of a business, something which is necessary for the survival and prosperity of a business. Just like revenue, even profits can be manipulated in many ways.

From hiding expenses to making a simple change in the way in which depreciation is calculated, there are numerous ways a company can manipulate its profits numbers. Some of the most common ways companies cook books in terms of profit are as follows:

— Making expenses look like earnings: A simple change in accounting policy can have a significant impact on the way profits are presented. Many companies use this approach to manipulate Net Profits.

For example, a simple change in the way depreciation is calculated can change the entire picture, helping company management boost profits.

For Example, a small change in depreciation policy in case of Jet Airways created profits out of thin air. In the Q2 of 2008-09, Jet airways changed its depreciation policy from written down value method to straight-line value method, as a result of which, Jet Airways was able to write back ₹920 crores to its Profit and Loss account.

— Hiding Expenses as Capital Expenditure: Another way to boost profits is by treating expenses as capital expenditure; that is instead of treating it as expenses during the current financial year, it is treated as investment made to expand the business.

One such incident can be found in the USA, wherein the years 1990, AOL was found guilty of delaying expense.

AOL was distributing installation CDs as a part of its marketing campaign, but instead of treating it as an advertising expense, AOL decided to view it as capital expenditure. As a result of this, the entire amount was transferred from profit and loss statement to balance sheet of the company where the campaign would be expended over a period of years.

Because of AOL’s treatment of expenses as Capital Expenditure, the entire amount was written off the P&L Statement, which resulted in boosted profits.

3. Cash Flow Manipulation:

Cash flow is considered to be the most reliable source of the true financial health of the company for the simple reason that cash is difficult to manipulate. Investors like Warren Buffett rely heavily on numbers like free cash flow to assess the financial health of the business.

Since companies know this well, they have devised new ways where it is possible to manipulate the cash flow of a company using accounting gimmicks.

Detecting such tricks can be quiet challenging for an amateur investor who does not have a deep understanding of accounting and finance or does not have free time to go through the books of the company.

Some of the most common cash flow related financial shenanigans are explained below:

— Showing financing cash flow as operating cash flow: There are two ways a company can generate cash for itself, first, from its own business, where profits earned by the business get converted to cash, and second by borrowing cash from an external source in the form of loan by issuing bonds or bank loan.

The cash received from business operations is called Cash Flow from Operating Activity, and cash received from an external source is treated as cash flow from financing activity.   

Many companies try to boost their operating cash flow by treating financing cash flows as operating one, which leads to a wrongful impression that the company is generating a lot of operating cash flow from its business.

— Using acquisitions as a boost to operating cash flow:

Cash flows can also be manipulated using mergers and acquisitions, especially if the target company is rich in cash.

Management often tries to win support from its shareholders by convincing the shareholders that a particular acquisition will be highly beneficial for the company.

As soon as the merger takes place, all the cash that belonged to the target company, now becomes a part of the parent company, thus boosting overall cash flow statements.

Investors must always be wary of the financial history of the target company and its business and find out if the merger is really going to benefit the business.

If an acquisition is happening just because it will boost the EPS or the cash flows of the parent company, with no meaningful benefit to the business, then such acquisitions must be avoided at all costs.

Also read:

Some Additional ways companies cook books:

cook books by companies

Cooking books is not limited to manipulating earnings or hiding crucial details about the weak performance of the company, management of companies go beyond the books and create their own parameters of measuring the growth and performance of a company.

Such parameters, though necessary in certain industries, are still non-standard as per the accounting standards. Because of such creative parameters, managements get an opportunity to change their definition of performance as per their requirements, allowing them to use creative methods to put encouraging but false performance numbers in front of investors.

Some of the examples of such no-standard parameters are explained below:

— Same Store Sales (Used In Retail Stores and Restaurants):

Same store sales is a parameter to measure the performance of retail stores. It gives information about how much sales revenue a store is generating during a fiscal year or more.

Same store sales also give investors an idea of how much revenue a company is generating from its existing stores and how much is contributed by new stores. If the percentage of sales revenue from new store sales is rising, it’s strong evidence that new stores are performing well, sounds rational, right?

This is where companies get a chance to manipulate with numbers without getting noticed. The management of the company may alter the criteria of eligible stores to be used in the metric.

For example, in one financial year, a company may use only those stores older than 3 years to show the same store sales performance while in the next year, if the performance of the stores older than 3 years deteriorates, the management may change the criteria and use only those stores that are older than 5 years.

Companies may keep changing their eligibility criteria as per their suitability to present the desired picture.

— ARPU (Average Revenue Per User):

ARPU stands for Average Revenue Per User and is a performance metric generally used by Telecom companies or DTH service providers. Just like same store sales, ARPU can also be used for manipulating earnings of a company.

Most telecom companies, especially in this age of smartphones, not only generate revenue from selling data, but also by selling ad space, and this is where the manipulation begins.

The right way to calculate ARPU is by calculating total revenue generated from data services provided divided by the total number of subscribers.

However, some companies, to show encouraging revenue growth add advertising revenue to the revenue from subscription, thereby falsely boosting the total ARPU.

How to detect if a company is cooking books?

cook the books

So far we have seen why and how companies cook books, but the biggest question is, is it possible to detect these financial shenanigans? How would you know that a company is cooking books?

While detecting some of these financial shenanigans requires a degree in finance, most of them can be traced pretty easily if you just observe carefully.

— Improved Revenue with an absence of Cash Flow:

If the complicated accounting terms are giving you nightmares, and you have no clue what to do, here is something very simple and logical thing you can do. Just Watch out for cash flow.

Increase in revenue of the company should be reflected with an increase in cash flow of the company. If you see operating cash flow declining or stagnant even if the revenue is marching upwards, or if cash flow is much slower than the revenue generated, it usually means that the company is generating revenue but is unable to collect cash, or even worse, the revenue numbers are simply fake and bogus.

— If Q1+Q2+Q3+Q4 is not equal to FY:

In an ideal situation, if the financial results are audited, the annual sales and profits should simply be a sum of all the four quarterly sales and profit numbers, except for minor variations.

If there is a significant variation between annual sales and profit numbers and sum of all quarterly numbers, you can say that the books have been manipulated at least to some extent.

— If a company is on an acquisition spree:

Companies make acquisitions as it helps the acquirers grow inorganically while making an acquisition, companies make sure that the interests of both the companies are aligned and that the resources that an acquiring company needs are available with the company that is being acquired, at a bargain price.

In simple words, any acquisition should add value to the company more than what is being paid for it. There are many instances when companies are on an acquisition spree. Firms that make numerous acquisitions can get into trouble, their financials get restated and complicated to understand.

Aside from complicating things, acquisitions usually increase the risk of cooking books and bury the evidence under many layers of financial statements. So if a company is a serial acquirer, but does not show significant improvement in its financial performance, there is a good chance that the acquisitions were made simply to manipulate the numbers.

— If the company has bulging Trade Payables:

Many companies, especially in a competitive, customer-centric market loosen their credit terms, attracting more customers to buy goods and services now and pay later. While this is a great move that helps boost sales revenue, it may create a liquidity crisis in a company.

Longer credit duration means that company has to wait longer for the revenue to be converted into cash, but since a company has to meet its daily expenses in cash form, longer credit means company may run out of cash and may have to either borrow to meet its operational expenses or shut down its operations completely.

The best way to cross-check if the company’s revenue is simply because of loose credit terms is to check if there is a change in days receivables in the past few financial years.

If a company has increased the receivable days, it shows that all the revenue is just on paper and the cash is yet to be realized. Such practice is pretty common in infrastructure companies.

— If the CFO and auditors resign or get fired:

This is by far one of the most vital signs that a company is cooking books. There is an old saying in Latin “Who Watches the Watchmen?” when it comes to financial reporting, the watchmen are the Chief Financial Officer (CFO), and the corporate auditor.

If you find a company that is involved in some of the suspicious accounting activities as mentioned above, and you see the CFO of the company quitting abruptly for no valid or logical reasons, its time to stand guard and find out if there is something going on within the company that has not met your eyes yet.

The same rule applies to corporate auditors. IF a company frequently changes its auditors or fires them after some accounting issues come to light, be watchful and look for warning signs.

There have been many recent examples of auditors resigning after altercation from the company owners, which later revealed that company was involved in dressing up numbers to make things look good on the surface while it was really bad inside.

In the month of May 2018, Deloitte, corporate auditor of Manpasand beverages quit a few days before the declaration of annual result as the company was unable to share crucial data regarding capital expenditure and revenue. As a result, the stock price of Manpasand beverages tanked 20% within a day. You can read the news by clicking here

Another such incident happened recently where PWC (Price Waterhouse Coopers LLP) statutory auditor of Reliance Capital and Reliance Home Finance, quit just before the declaration of FY19 results.

In its resignation letter, PWC stated that as part of the ongoing audit for FY19, it noted certain observations and transactions, which, in its assessment, if not resolved satisfactorily, might be significant or material to the financial statements. You can read the new by clicking here

Conclusion:

If you are looking for a great investment, look for great businesses. The best way to understand if a business id great or not is by analyzing the financial statements of the company.

Since every investor relies on financial statements for his analysis, it’s important that companies remain honest and transparent and give only authentic information.

However, with the ever-mounting competition, and a race to perform better than peers puts a lot of pressure on the management to perform, because of which they often resort to unethical ways to manipulate the number so that the business “appears” healthy.

There is an Old Russian Proverb which means “Trust, but Verify”, taking things at face value can be dangerous and thus it is important that investors, even if they trust the management with the numbers, should always be vigilant and keep checking the authenticity before making an investment decision, after all, it’s your hard-earned money at risk, don’t take anyone else’s word for it.

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About the Author:

This article is a guest post by Ankit Shrivastava, a SEBI Registered Research Analyst. Ankit has been investing in stocks since 2004 and writes about fundamental analysis of companies, principles of investing, investment strategies and a lot more on his blog: Infimoney

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July 4, 2019 Beginner's guide, Guest Post, Valuations 1 comment
Do You Need a Finance Degree For a Career in Stock Market cover

Do You Need a Finance Degree For a Career in Stock Market?

The finance industry in India has been growing at a very fast pace since last two decades. And along with the growth in the industry, there’s also a boom in job opportunities and enthusiasts willing to work in this field.

Although there are many job opportunities available in the stock market, however, one of the most frequently asked questions is- “Can a student from non-finance degree get a job on Dalal street?” How much relevant is having a finance, commerce or business degree to land a job in the world on the stock market.

Well, the short answer to this question is that you do not need a finance or business degree to get all the jobs in the stock market. A lot of financial companies hire employees from Engineering, mathematics, science, computing or economics background. In the era of internet technology, most of the financial giants are looking more for the skills and the aptitude of the candidates rather than just the degree.

Anyways, there are still a few careers in the market like Investment Banking, Equity Research, Risk Management, Investment Management, etc where a special skill set and expert knowledge of finance is required and having a degree can give an advantage to the candidates.

Nonetheless, having or not having a finance/commerce/business degree is just the starting point. There are a lot more things that you need to know if you want to build a career in the stock market industry which we are going to discuss in this post.

It’s always beneficial to have a background in Finance

When you have a background in finance, business, accounting or commerce, you already have got a minor exposure to the investing world. You might already know the lingo and familiar with the frequently used terms in the stock market like dividends, assets, liabilities, etc.

On the other hand, most of the non-finance guys are not even familiar with the most common terms of the market. Moreover, they find reading and understanding financial statements is quite challenging compared to people with a finance background.

Getting a job at Dalal Street Market

In a scenario where you are appearing in a job interview for a financial position, knowing these financial terms can help you impress the interviewer or at least not feeling like a dumb one. Besides, as stated, in a few financial positions, the interviewers create a barrier by shortlisting only candidates with a graduate degree in finance, commerce, business or accounting. And in all these cases, having a degree can be advantageous for you.

Moreover, if you want to become a SEBI registered investment advisor or research analyst, you will require an educational qualification of graduate or post-graduate degree in finance/accounting/commerce, etc. If you don’t meet the educational qualification, you cannot become a SEBI registered advisors/analyst and hence can’t have a career in the advisory field.

Overall, if you’re planning to become an investment advisor/research analysis, you’ll require a degree in these fields. Nonetheless, you can always enroll in post-graduate degrees of one or two years to get the degree and meet the educational qualifications.

Also read: What are the Different Career Options in Indian Stock Market?

Managing your own portfolio

When it comes to trading & investing or managing your own portfolio, you don’t require any degree.

Anyone can open their trading accounts and start trading in stocks. Many engineers, math/science major, arts graduate or even people who don’t have any degree have been investing successfully and made a huge fortune from the market. A lot of successful stock market traders/investors do not have any background in finance or never did any course in this field. One of the best examples is Charlie Munger, a successful stock investor and vice-chairman of Berkshire Hathaway.

In short, if you are not interested in a 9-to-5 job or career in the Dalal street and just want to trade in stocks on your own, you won’t require any degree or certification. Here you can make money by using your knowledge and skill sets.

What to do when you don’t have a degree in Finance/Commerce?

It’s often said that Self-Education is the best form of learning. Even though if you do not have a degree in finance, you can learn the skills and impress the interviewer with your enthusiasm to master the market.

Start by learning the lingo. It’s really important to know financial terms if you want to break the initial barrier of entering the stock market world. Know the most frequently used investing terms and how to read the financial statements.

Further, if possible, take a few online courses to learn the trading/investing concept. Attend local investing workshops, seminars, etc. It would be best if you can find a mentor. Expand your knowledge base and try simulating platforms to trade in stocks without risking your money. And finally, try to land an internship in the finance company so that you can have a real experience of how things work in this industry.

Closing Thoughts

Most people believe that a career in stock market is only for the people with finance or business background. But this is not true. Do not stop yourself from entering the exciting world of the stock market just because you do not have a finance degree. Here, having a skill set is more important compared to a degree. Moreover, even if you do not have a graduation degree in Finance/Commerce, you can go for reputed financial certifications like CFA, FRM, PRM etc that will put you on the same position as those with degrees.

My final advise will be to focus on enhancing your skills and acquiring specialized knowledge. This will help you more in building your dream life than chasing over degrees.

May 15, 2019 Beginner's guide 2 comments
How to Invest in Share Market? A complete Beginner’s guide

How to Invest in Share Market? A Beginner’s Guide

Hi Investors. Today we are going to discuss one of the most basic topics for a beginner- How to invest in share market? I have been planning to write this post for a number of days as there are many people who are willing to invest, however, do not know how to invest in share market.

Please note that this post might be a little longer as I am trying to cover all the basics that a beginner should know before entering the stock investment world. Make sure that you read the article till the end, cause it will be definitely worthwhile reading it.

Pre-requisites before you start investing

For investing in the Indian stock market, there are few pre-requisites that I would like to mention first. Here are the few things that you will need to invest in share market:

  1. Savings account
  2. Trading and demat account
  3. Computer/laptop/mobile
  4. Internet connection

(Thanks to Reliance Jio, everyone has 4G internet connection now.. 😀 )

For opening a demat account, the following documents are required:

  1. PAN Card
  2. Aadhar card (for address proof)
  3. Canceled cheque/Bank Statement/Passbook
  4. Passport size photos

You can have your savings account in any private/public Indian bank.

Where to open your trading and demat account?– This will be discussed later in this post on the section ‘choose your stock broker’ (STEP 4).

Get your documents ready. If you do not have a PAN card, then apply as soon as possible (if you are 18 years old or above).

3 basic advice before you start investing

When you are new to the stock market, you enter with lots of dreams and expectations. You might be planning to invest your savings and make lakhs in return.

Although there are hundreds of examples of people who had created huge wealth from the stock market, however, there are also thousands who didn’t.

Here are a few cautionary points for people who are just entering the world of investing.

— Pay down your debts first

If you have any kind of ‘high-interest’ paying debts like personal loans, credit card dues debts, etc, then pay them first. There is no point in wasting your energy to give all the returns you made from the market as interests of your debts. Pay down these debts before entering the market.

— Invest only your additional/ surplus fund

Stop right there if you are planning to invest your next semester tuition fee, next month flat rent, savings for your daughter’s marriage which is going to happen next year or any similar reasons.

Only invest the amount that won’t affect your daily life. In addition, investing in debts/loans is really a bad idea, especially when you are new and learning how to invest in the share market.

— Keep some cash in hand

The cash in hand doesn’t just servers as your emergency fund. It also serves as your key to freedom. You can take big steps like changing your little flat, or quit your annoying job or simply shifting to a new city, only when you have cash in hand.

Do not get trapped by investing all your money and later losing your freedom. Do not sacrifice your personal freedom in the name of financial freedom.

Also read: 7 Things to do Before You Start Investing

Now that you have understood the pre-requisites and the basics, here are the 6 steps to learn how to invest in share market on your own. Do follow the step sequences for an easy approach to enter the stock market world.

How to invest in share market?

Step 1: Define your investment goals

investment goal

It’s important to start with defining your investment goals. Start with end goals in mind. Know what you want.

The time frame for different investment goals will be different. Your goal can be anything like buying a new house, new car, funding your higher education, marriage, retirement, etc.

If you are investing for your retirement, then you have a bigger time frame compared to if you are investing for your higher education. When you know your goals, you can decide how much you want and for how long you have to remain invested.

Also read: Why Goal-Based Investing?

Step 2: Create a plan/strategy

Now that you know your goals, you need to define your strategies. You might need to define whether you want to invest in the lump sum (a large amount at a time) or by SIP (systematic investment plan).

If you are planning for SIP, define how much you want to invest monthly. (Related post: SIP or Lump sum – Which one is better?)

Step 3: Read some investing books.

There are a number of decent books on stock market investing that you can read to brush up the basics. Few good books that I will suggest the beginners should read are:

Besides, there are a couple of more books that you can read to build good basics of the stock market. You can find the list of ten must-read books for Indian stock investors here.

Step 4: Choose your stock broker

Deciding an online broker is one of the biggest steps that you need to take. There are two types of stockbrokers in India:

  1. Full-service brokers
  2. Discount brokers

— Full-Service Brokers (Traditional Brokers)

They are traditional brokers who provide trading, research, and advisory facility for stocks, commodities, and currency. These brokers charge commissions on every trade their clients execute. They also facilitate investing in Forex, Mutual Funds, IPOs, FDs, Bonds, and Insurance.

Few examples of full-time brokers are ICICIDirect, Kotak Security, HDFC Sec, Sharekhan, Motilal Oswal, etc

— Discount Brokers (Budget Brokers)

Discount brokers just provide the trading facility for their clients. They do not offer advisory and hence suitable for a ‘do-it-yourself’ type of clients. They offer low brokerage, high speed and a decent platform for trading in stocks, commodities and currency derivatives.

A few examples of discount brokers are Zerodha, ProStocks, RKSV, Trade Smart Online, SAS online, etc.

Read more here: Full service brokers vs discount brokers: Which one to choose?

I will highly recommend you to choose discount brokers (like Zerodha) as it will save you a lot of brokerage charges.

Initially, I started trading with ICICI direct (which is a full-service broker), but soon realized that it was too expensive when compared to discount brokers. It doesn’t make sense to pay extra brokerage charges even if you get similar benefits. And that’s why I shifted to Zerodha as my broker. (Related Post: Different Charges on Share Trading Explained- Brokerage, STT & More)

Zerodha (a discount broker) charges a brokerage of 0.01% or Rs 20 (whichever is lower) per executed order on Intraday, irrespective of a number of shares or their prices. For delivery, there is a zero brokerage charge in Zerodha. Therefore, the maximum brokerage that you’ve to pay per trade while using the Zerodha platform is Rs 20 and it doesn’t depend on the volume of trading.

open account with zerodha

This is way cheaper compared to ICICI direct (full-service broker) which asks a brokerage of 0.55% on each transaction. If you buy stocks for Rs 50,000 in ICICI direct, then you have to pay a brokerage of Rs 275 for delivery trading i.e. when you hold the stock for more than one day in your demat account.

Further, as this amount is charged on both sides of the delivery transaction (buying & selling), hence you have to pay a total of Rs 550 for the complete transactions in ICICI direct (way too expensive than Zerodha).

In short, if you are planning to open a new trading account, I would recommend opening accounts in a discount broker so that you can save lots of brokerages. If you’re interested to open your account with Zerodha, here’s the direct link to fill account opening application!

Zerodha-open-an-account

Related Posts:

Step 5: Start researching common stocks and invest.

Start noticing the companies around you. If you like the product or services of any company, dig deeper to find out more about its parent company, like whether it is listed on the stock exchange or not, what is its current share price, etc.

Most of the products or services that you use in day to day life — From soap, shampoo, cigarettes, bank, petrol pump, SIM card or even your inner wears, there is a company behind everyone. Start researching about them.

For example- if you’ve been using HDFC debit/credit card for a long time and satisfied with the experience, then investigate further about HDFC Bank. The information of all the listed companies in India is publicly available. Just a simple google search of ‘HDFC share price’ will give you the following pieces of information.

hdfc bank share price sept 2019

Similarly, if your neighbor bought a new Baleno car lately, they try to find out more about the parent company, i.e. Maruti Suzuki. What other products it offers and how is company performing recently- like how are its sales, profits, etc.

You do not need to start investing in stocks with hidden gems. Start with the popular large-cap companies. And once you are comfortable in the market, invest in mid and small caps.

Also read:

Step 6: Select a platform to track your performance

You can simply use an excel sheet to track the stocks. Make an excel sheet with three tables containing:

  1. The stocks that you are interested in and need to study/investigate,
  2. Those stocks that you have already studied and found decent,
  3. Miscellaneous stock- for the other stocks that you want to track.

This way, you can easily follow the stocks. Further, there are a number of financial websites and mobile apps that you can use to keep track of the stocks.

Related post: 7 Best Stock Market Apps that Makes Stock Research 10x Easier.

Step 7: Have an exit plan

Its always good to have an exit plan. There are two ways to exit a stock. Either by booking profit or by booking loss.

If your investment goals are met, then you can exit the stocks happily. Further, if the stock has fallen under your risk appetite level, then again exit the stock. Also, keep in mind the time frame till which you want to remain investing before exiting. It’s really important that you know how to take out your money.

Also read: What are the capital gain taxes on share in India?

There were seven steps that will help you learn how to invest in the share market. Now, here are a few other important points that every stock market beginner should know:

10 Additional points to take care

1. Start small

Do not put all your money on the market in the beginning. Start small and test what you have learned. You can start even with an amount of Rs 500 or 1000. For the beginners, it’s more important to learn than to earn. 

You can invest in a large amount once you have more confidence and experience.

2. Diversify your portfolio

It’s really important that you diversify your portfolio. Do not invest all in just one stock. Buy stocks from companies in different industries.

For example, two stocks of Apollo Tyres and JK Tyres in your portfolio won’t be called as a diversified portfolio. Although the companies are different, however, both companies belong to the same industry. If there is a recession/crisis in tyre sector, then your entire portfolio might be in RED.

A diversified portfolio can be something like Apollo tyres and Hindustan Unilever stocks in your portfolio. Here, Apollo Tyres is from Tyre industry and Hindustan Unilever is from FMCG industry. Both the stocks are from different industry in this portfolio and hence is diversified.

Also read: How to create your Stock Portfolio?

3. Invest in blue-chip stocks (for beginners)

Blue chips are the stocks of those reputed companies who are in the market for a very long time, financially strong and have a good track record of consistent growth and returns in the past many years.

For example- HDFC banks (leader in the banking sector), Larsen and turbo (leader in the construction sector), TCS (leader in the software company), etc. A few other examples of blue-chip stocks are Reliance Industries, Sun Pharma, State bank of India, etc.

These companies have stable performance and are very less volatile. That’s why blue-chip stocks are considered safe to invest compared to other companies.

It’s recommendable for beginners to start investing in blue chips stocks. As you gain knowledge and experience, you can start investing in mid-cap and small-cap companies.

Also read: What are large-cap, mid-cap and small-cap stocks?

4. Never invest in ‘FREE’ tips/advice

This is the biggest reason why people lose money in the stock market. They do not carry enough research on the stocks and blindly follow their friends/colleague’s tips and advice.

The stock market is very dynamic and it’s stock price and circumstances change every second. Maybe your friend has bought that stock when it was underpriced, however now it’s trading at a higher price range. Maybe, your friend has a different exit strategy than yours. There are a number of factors involved here, which may end up with you losing the money.

Avoid investing in tips/advice and do your own study.

5. Avoid blindly following the crowd

I know a number of people who have lost money by blindly following the crowd. One of my colleagues invested in a stock just because the stock has given double return to another of my college in 3 months. He ended up losing Rs 20,000 in the market just because of his blind investing.

Related post: 6 Reasons Why Most People Lose Money in Stock Market

6. Invest in what you know and understand

Will you buy ABC company which produces Vinyl sulphone easter and dye intermediates even though you have zero knowledge of the chemical industry?

If you will, then it’s like giving some stranger 1 lakh rupee and expecting him to return the money with interests.

 If you are lending money to someone, you ask a number of questions like what he does, what is his salary, what is his background, etc.

However, while investing Rs 1 lakh in a company which people do not understand, they forget this common logic.

7. Know what to expect from the market

Do not set unrealistic expectations for the stock market. If you want to make your money double in one month, from the stock market, then you have set your expectations wrong. Have a logical expectation form the market.

People are happy with 4% simple interest from the savings account, but a return of 20% in a year sounds underperformance for them.

Also read: How To Select A Stock To Invest In Indian Stock Market For Consistent Returns?

8. Have discipline and follow your plan/strategy

Do not get distracted if your portfolio starts performing too well or too bad in the first few months of investing. Many people increase their investment amount just in few weeks if they see their stock doing too well, and end up losing in the long run.

Similarly, many people exit the market soon and are not able to get profits when their stocks start performing.

 Have discipline and follow your strategy.

9. Invest regularly and continuously increase your investment amount

The stock investment gives the best returns when you invest for the long term. Do not invest in lump sump at just one time and wait for the next 10 years to see how much returns you got. Invest regularly whenever you get a good opportunity. 

Further, increase the investment amount as your savings increase.

10. Continue your education

Keep learning and keep growing. The stock market is a dynamic place and changes continuously. You can only keep up with the stock market if you also continue your education.

Besides, there are a number of more lessons which you will learn with time and experience.

Ready to start your journey to become a succesful stock market investor? If yes, then here’s an amazing course for newbie investors: HOW TO PICK WINNING STOCKS?

That’s all for this post on how to invest in the share market. I hope this is helpful to the readers. If you have any doubts, feel free to comment below.

November 7, 2018 Beginner's guide, Investment Basics 68 comments
27 Key terms in share market that you should know

27 Key terms in share market that you should know

When I first entered the investing world, I spend a lot of time googling the key terms in share market. Definitely, Investopedia was my favorite website to learn the meaning of those words. Although there are thousands of terminologies that a stock market investor/trader should know, however, they are a handful of them which are repeatedly used. This basic domain knowledge of these terms is really important if you want to enter and succeed in the share market.

In this post, we are going to present an elementary guide for the beginners to help them understand the key terms in share market. Let’s get started.

27 Key terms in share market that you should know:

Share: A share is the part ownership of a company and represents a claim on the company’s assets and earnings. It fluctuates up or down depending on several different market factors and is exchangeable at stock exchanges. As you acquire more stock, your ownership stake in the company becomes greater.

Shareholder: An individual, institution or corporation that legally owns one or more shares of stock in a public or private corporation are called shareholder. Shareholders have a claim on the company’s ownership.

Primary market: Also known as New Issue Market (NIM). It is the market place where new shares are issued and the public buys shares directly from the company, usually through an IPO. The company gets the amount on the sale of shares.

Secondary Market: It is the place where formerly issued securities are traded. The second market involves indirect purchasing and selling of shares among investors. Brokers are Intermediary and the investors get the amount on the sale of shares.

Intraday: When you buy and sell the share on the same day, then it is called intraday trading. Here the shares are not purchased for investing, but to get profits by harnessing the movement in the market.

Delivery: When you buy a share and hold it for more than one day, then it is called delivery. It doesn’t matter whether you sell it tomorrow, after 1 week, 6 months or 5 years. If you hold the stock for more than one day, then it is called delivery.

bull vs bear - key terms in share marketBull market: This is a term used to describe the scenario of the market. A bull market is when the share prices are rising and the public is optimistic that the share price will continue to rise.

Bear Market: When the share prices are falling and the public is pessimistic about the stock market, then it’s a bear market. The public is fearful and thinks that the market will continue to fall and hence, selling increases in this market.

Also read: What is Bull and Bear market? Stock Market Basics

IPO: When a privately listed company offers its sharers first time to the public to enter the share market, then it is called initial public offering.

Blue chip stocks: These are the stocks of those reputed companies who are in the market for a very long time, financially strong and have a good track record of consistent growth and returns in the past many years. Their stocks have low risk compared to mid cap and small cap stocks.

Broker: A stockbroker is an individual/organization who is a registered member of the stock exchange and are given license to participate in the securities market in place of its clients. Stockbrokers can directly buy & sell stocks in the share market on behalf of their clients and charge a commission for this service.

Portfolio: A stock portfolio is grouping all the stocks that you are holding. A portfolio shows the different stocks and the quantities that you are holding. It’s important to build a good portfolio to maintain risk-reward in the stock market.

Also read: How to create your Stock Portfolio?

stock-market-buy-sellStock Exchange: Just like a vegetable market, exchanges act as a market where the stock buyers connect with stock sellers. There are two big stock exchanges in India- Bombay stock exchange (BSE) and National stock exchange (NSE).

Dividend: Whenever a company (whose shares you are holding) is in profit, the company can either reinvest the profit or distribute the amount among its shareholders. This share of the profit that you get from the company is called dividend.

Companies may or may not give dividends to their shareholders depending on their needs. If it’s growing fast, it might re-invest the profit in its expansion. However, if it has enough cash, the company will distribute it among its shareholders.

Index: Since there are thousands of company listed on a stock exchange, hence it’s really hard to track every single stock to evaluate the market performance at a time. Therefore, a smaller sample is taken which is the representative of the whole market. This small sample is called Index and it helps in the measurement of the value of a section of the stock market. The index is computed from the prices of selected stocks.

Sensex is the index of BSE and consists of 30 large companies from BSE. Nifty is the index of NSE and consists of 50 large companies from NSE.

Also read: What is Nifty and Sensex? Stock Market Basics for Beginners

Limit Order: Limit order means to buy/sell a share with a limit price. If you want to buy/sell a share at a given price, then you place a limit order. For example, if the current market price of ‘Tata motors’ is Rs 425, however you want to buy it at Rs 420, then you need to place a limit order. When the market price of Tata motors falls to Rs 420, then the order is executed.

Market order: When you want to buy/sell a share at the current market price, then you need to place a market order. For example, if the market price of ‘Tata Motors’ is Rs 425 and you are ready to buy the share at the same price, then you place a market order. Here, the order is executed instantaneously.

Good till cancellation (GTC) order: This order can be placed when an investor is willing to buy/sell the shares at a specific price and the order remains active till it is executed or canceled.

Day order: This order can be placed when an investor is willing to buy/sell shares on a particular day and the order gets automatically canceled if not fulfilled on that day.

Note: If you are new to share market and want to learn how to pick winning stocks, then here is an amazing crash course that I highly recommend you to check out.

Trading volume: It is the total number of shares being traded at a particular period of time. When securities are more actively traded, their trade volume is high. Higher trade volumes for a stock mean higher liquidity, better order execution and a more active market for connecting a buyer and seller.

Volatility: It means how fast a stock price moves up or down. More volatile assets are considered riskier than less volatile assets because the price is expected to be less predictable and may fluctuate dramatically.

Liquidity: Liquidity means how easily you can buy/sell a share without affecting the share price. A highly liquid share means that it can easily be bought or sold. A low liquid stock means that the buyers/sellers are hard to find.

Short selling: It is a practice where the trader sells share first (which he doesn’t even own at that time) and hope that the price of that share starts falling. He will make a profit by buying back those shares at a lower price. Overall, both selling and buying are done here, however, it’s sequence is opposite to the regular transactions to get the profit of the falling share prices. 

Going long: This is buying the shares in expectations that the share price is going to increase. When a trader say I am “Going long…” or “Go long”, it indicates his interest in buying a particular share.

Average down: This is an approach that investors use to buy more shares when the share price starts falling. This results in an overall lower average price for that share. For example, you bought a stock at Rs 100. Then the stock price starts falling. You bought the stock again at Rs 80 and Rs 60. Hence, the average price of your investment will be lower i.e. Rs 80. This is the approach used in averaging down.

Public float (free float): Public float or free float represents the portion of shares of a company that is in the hands of public investors.

Market capitalization: It refers to the total rupee value of the company’s share. It is calculated by multiplying the total number of shares by its present market share price. We define large cap, mid cap or small cap companies based on their market capitalization.

Also read: Basics of Market Capitalization in Indian Stock Market.

Bonus:

Bid: The bid price represents the maximum price that the buyer/buyers are willing to give to buy a share.

Ask: This is the minimum price that the seller/sellers are willing to receive to sell their shares.

Bid-Ask spread: This is the difference between the ‘bid’ and ‘ask’ price of a share. Basically, its the difference between the highest price that the buyers are willing to buy a share and the lowest price that the sellers are willing to sell their shares.

Demat account: It is the short form for ‘Dematerialised account’. The demat account is similar to a bank account. Just as money is kept in your saving account, similarly bought stocks are kept in your demat account.

Trading Account: This is a medium to buy and sell shares in a stock market. In simple words, the trading account is used to place buy or sell order for a share in the stock market.

Margin: Trading on margin means borrowing money from your stock brokers to purchase stock. It allows the traders to buy more stocks than you’d normally be able to.

That’s all. Apart, there are thousands of more terminologies involved in trading/investing. However, these are the key terms in share market that a beginner should know. I hope this is helpful to the readers. Comment below if I missed any key term in share market that should be listed in this post. Happy Investing.

November 21, 2017 Beginner's guide, Investment Basics 31 comments
how to start investing in share market?