Stocks: the basic fundamentals of investing
Stocks are a popular investment tool. Let’s look at the peculiarities of working with this tool from the perspective of a novice investor. Stocks are the efficient systems of the modern world economy. Accordingly, there are two main groups interested in the stock market. On the one hand, these are owners of free capital, or investors.
Their goal is to invest capital with maximum return or profitability for themselves and their clients. On the other are the shareholders, or stock owners. They seek to maximize the value or quantity of the stock they own or have been entrusted. Both groups share a common interest in increasing equity.
The interests of investors and shareholders meet and are satisfied on the stock market, which ensures the free flow of capital from one enterprise to another. Here, there are various parties, each fulfilling a specific function:
- An issuer is a person (for example the state, the local government or a joint-stock company), on whose behalf securities have been issued to develop and finance its activities.
- An investor is a person or organization that allocates capital for the purpose of making a profit.
Professional participants in the securities market include:
- Forex dealers
- Trust managers
- Investment advisors
Stocks are securities issued by a company. Let us consider this popular investment tool from an investor’s perspective. An investor buys shares in order to participate in the capital of a company and receive additional income. There are two types of shares – ordinary and preferred: they differ in the set of rights which give their owner.
Ordinary shares give the right to vote at shareholders’ meetings, the opportunity to participate in the distribution of profits, but do not guarantee receipt of dividends. Preferred shares do not give the right to vote at shareholders’ meetings, except in certain cases, when decisions are made:
- on the reorganization and liquidation of the joint stock company,
- change of the type of joint stock company,
- on introduction of amendments and (or) additions to the Charter of the joint-stock company, restricting their rights, including in terms of dividend payments.
Important characteristics of shares:
- Liquidity – the ability to quickly sell or buy at a price close to the market price.
- Nominal price – reflects the amount of the company’s share capital.
- Market price – the value established by quotations on the stock exchange based on the balance of supply and demand.
- Yield is made up of dividends (payment of part of the company’s profits) and/or an increase in the exchange value.
At the beginning of the portfolio formation, an investor needs to make an individual investment strategy to understand which stocks are worth investing in or not. Predictable losses are nothing to be afraid of. Spontaneous ill-considered decisions and lack of a clear-cut strategy are a sure way to have a negative investment result.
You need to set a goal. Is it to protect deposits from inflation or devaluation, to increase capital with low risk or to try to get rich quickly? What volume of losses is an investor ready to incur? Answers to these questions will help determine the approaches to strategy selection, allowable positions in the portfolio, and prevent distraction from short-term speculative temptations.
An investor should consider a combination of many parameters: financial goals, risk tolerance, desired return, and investment time horizon. The investor should realize that in case of necessity the possibility to sell the stock in a liquid way, i.e. with the minimum losses and in the shortest possible time depends on the current market situation, not on his desire. That is the desire to sell, does not mean the presence of buyers. Sometimes there may be not enough of them to sell the entire volume. Or, on the contrary, too many, when buying shares.
Peculiarities of transactions in shares
You can trade stocks by opening an account with a brokerage company. Transactions are made during the trading session. The schedule and mode of trading are published on the websites of stock exchanges.
Example: settlement and delivery of shares on the Moscow Exchange is standard on the second business day (T+2 mode) – this should be taken into account in calculations. Thus, when closing the register for dividends, to receive dividends shares must be purchased 2 working days before the event.
Why does the investor need the shares?
This is potentially more profitable than bonds or deposits. However, it is also riskier!
Low entry threshold: an investor can buy 1 or more shares with little capital.
Unlike bonds, they give the opportunity to participate in the management of the company.
Listing of securities
Listing is the inclusion of securities by a trade organizer into the list of those admitted to organized trades for the purpose of concluding purchase and sale agreements, including the inclusion of securities into the quotation list by a stock exchange.
Listing can be done with or without inclusion in the quotation lists – the List of securities admitted to trading on the exchange.
The list consists of three sections:
- Level One
- Second level
- Level Three
In order to be listed, a security and its issuer must meet the requirements set forth in the Exchange Listing Rules. Obviously, companies differ from one another in many ways. Their financial results, size, industry and other factors create different risks when investing. Standardized exchange requirements make a company more transparent to the private investor. The tiering provides primary information about how well a company meets the exchange’s high requirements and helps determine the level of risk for an investment. This allows a wide range of investors to make an informed choice of securities.
Tiers One and Two are quotation lists. Level Three is the unquoted part of the list. The first level – “the major league” – gives admittance to trade in securities of famous issuers. Such heavyweights as Sberbank, Rosneft, Lukoil and other blue chips are traded on it.
The principles for Tier One and Tier Two are similar, the difference is the scale of requirements:
- on capitalization
- the market price of the free float
- the term of existence of the company
- reporting for the last 3 calendar years
- on corporate governance
- disclosure of information.
Level 3 requirements are an entrance ticket to a stock exchange. Securities of this level are not presented in the quotation list. For a Level Three listing, the Exchange sets minimum requirements for companies:
- compliance of the securities with legal requirements ;
- register a prospectus;
- disclosure of information in accordance with the Securities Act.
What are the risks when investing in stocks?
- One of the main postulates when working with risky assets, that is stocks, is that income from previous periods does not guarantee income in the future. This is why an investor, especially a beginner, must fundamentally determine what level of risk is acceptable to him personally.
- Funds deposited on the brokerage account are not subject to insurance, unlike bank accounts and deposits. The interest on deposits is known, a certain amount of the deposit is protected by the state. The interest or coupon on bonds is also determined at the entry into the transaction. With stocks things are different: the higher the income, the higher the risk. Equity markets can be extremely volatile, especially when the market and economic situation changes.
- To minimize risks, it’s worth choosing a reliable broker with proven experience in the professional securities market. It is worth using strategies of assets diversification, combining stocks of different companies from different economic spheres in your portfolio. The proverb “Don’t put all your eggs in one basket” encapsulates the essence of the principle of a balanced asset allocation.
And if losses from transactions with the shares are still received? And here the government has provided a way to smooth the losses. Of course, no one will compensate for losses. This should be kept in mind when starting a deal with any securities, not only with stocks.
However, the Tax Code provides for some peculiarities of determining the taxable base, calculation, and payment of income tax on operations with securities and on operations with financial instruments of term transactions for those who have failed on the stock market.
Thus, it is possible to reduce the taxable base for shares. It is also possible to offset losses and/or transfer losses to the future. The loss received in the current tax period can be carried forward within 10 years following that tax period, in which it was received. However, a loss not carried forward to the next year may be carried forward in whole or in part to the next year of the next nine years.
What if the brokerage company through which the investor was serviced goes bankrupt or is liquidated? All securities are protected by law. In this case, the investor can transfer the shares to another broker’s depository or withdraw them from the register. It is important to know that any securities purchased by the account holder are recorded in the electronic register and cannot be sold, transferred, or “lost” without their participation.