Understanding Stock Prices & Returns

Welcome to our comprehensive blog on stock prices and returns! In this blog, we will explore the fascinating world of investment instruments and help you understand the concepts of stocks, stock prices, and returns. Whether you are a beginner or someone looking to expand your knowledge in the field of investing, this blog will provide you with valuable insights and easy-to-understand explanations.

What Are Stocks?

Before we delve into the discussion of stock prices and returns, let's first understand what stocks are. When you purchase stocks of a company, you become a partial owner of that company, and the stock owners are referred to as shareholders. If you want to learn more about stocks and their basics, we recommend checking out our first chapter, "Introduction to Stocks," in our course called "Basics of Stocks." 

Understanding Stock Prices

Now, let's talk about stock prices and returns. The stock market is a marketplace where companies raise funds for their growth and expansion projects, and as individuals, we can participate in their growth by investing in their stocks. However, do stock prices always go up? Not necessarily! In the stock market, share prices fluctuate every second.

The price of a stock is based on the principles of supply and demand. When the demand for a stock exceeds its supply, the value of that share increases. The larger the gap between demand and supply, the higher the share price becomes. Let's understand this with an example: If a large number of investors are buying a stock, let's say Stock X, its share value will increase. Conversely, if people start selling that stock, the value will decrease.

Why do Stock Prices fluctuate?

Several factors influence the rise or fall in stock prices. Let's discuss a few of them:

1. Earnings of the Company

Investors often prefer to invest in companies that generate good profits and are in high demand. When a company shows consistent growth in its earnings per share, the demand for its shares increases. Listed companies are required to share their profit and loss information in their quarterly and annual earnings reports. By analyzing these reports, you can easily determine if a company's earnings are higher or lower than the projected estimates.

If a company demonstrates robust growth per share, the demand for its shares is likely to increase. However, if a company consistently falls short of its earnings projections, it may lead to a decrease in the value of its shares, as its performance fails to meet investors' expectations.

2. Market Sentiment

When a company takes on new projects, acquires other companies, or enters new markets, it needs funds for expansion. If the expansion is successful, it improves the company's financial health, leading to an increase in its share value. Conversely, if a company needs to sell a portion of its shares, lay off employees, or close some branches, it indicates financial struggles in its earnings. 

In such situations, investors may start selling the company's shares, fearing a significant drop in their value or even the potential closure of the company. Investors become fearful because their money is invested in the company.

Changes in the overall industry can also impact market sentiment, thereby affecting stock prices. 

For example, if investors have high confidence in the Electric Vehicle industry, the stock prices of electric vehicle companies can soar. This increased demand can also benefit other companies indirectly related to the industry, causing their stock prices to rise.

Market sentiment towards a particular industry can also be influenced by government policies or significant financial events like the annual budget.

3. Overvaluation vs Undervaluation

Let's start by understanding undervalued shares. Undervalued shares are those whose market price is lower than their actual value. However, this doesn't mean that these shares are bad investments. In fact, if a company's shares are undervalued, it presents an opportunity. Expert investors actively seek undervalued shares because they believe that the company's financial or operational performance will improve in the future, leading to increased demand and a rise in share prices.

On the other hand, overvaluation occurs when a company's share price exceeds its actual value. This can happen due to emotional trading or impulsive decision-making, where logic takes a back seat, and the value of investments is artificially inflated.

Calculating Profit or Loss

Investing in stocks can result in either profit or loss. Let's see how we calculate returns using two examples:

First, let's consider Rajat's investment in Paytm shares. Rajat purchased 100 shares of Paytm during the initial public offering (IPO) at a price of Rs. 2,150 per share. Later, he sold all the shares on November 21st at a price of Rs. 532 per share. You may be wondering how much loss Rajat incurred from this investment. To calculate the percentage loss, we use the formula: (Selling price of the share divided by the purchase price) multiplied by 100. Applying this formula, Rajat's total loss would be approximately -75%.

Calculating returns is crucial, as it determines whether you make a profit or a loss. The outcome depends on various factors, such as your research, investment strategy, market conditions, and the stocks you choose.

Let's explore another example that demonstrates how stock returns can earn you dividends:

Suppose Gaurav owns shares of Page Industries, and the company declares a dividend of Rs. 70 per share. If Gaurav has 10 shares, he would receive a total dividend of Rs. 700. How did we calculate this? We multiplied the declared dividend per share by the number of shares to obtain the total dividend.

Key Takeaways

• Understanding the factors that influence stock prices, such as earnings, market sentiment, and overvaluation/undervaluation is crucial.
• Calculating profit or loss allows you to assess the success of your investments and determine returns.
• Investing in stocks carries risks, so conducting thorough research, staying updated with market trends, and developing a sound investment strategy are important.
• Gaining knowledge and staying informed increases your confidence in navigating the stock market and improves your chances of achieving financial goals.