I recently started exploring the stock-market. I have been out of my college for more than 15 years, I am an Engineer, and I have worked really hard in various multi-nationals, contributed directly to product-based companies, creating new solutions, fixing things that were not behaving functionally correct, performance tuning others, proposing ideas for improvement, small and big, Keizen and Innovation, implementing and deploying solutions, delivering and releasing quality products. I rarely thought about earning exorbitantly more than what was really sufficient for me except that it should be enough to have some % directed towards savings for the future.
The smart money-experts would call me and ask me to put the money to make more money and I would disregard that thought. Not just disregard, but I also felt unpleasant to even think about it. We lived well within our means and I did have the money kept in savings account, mostly. I was working hard, earning well, saving well, and was (and I am) a good contributing-member of the society. What made that thought of “money-making-more-money” ugly (for me) was the ingrained notion that you need to sweat, to put labor, to be of service, to create something, to become worthy, to add value so that you get paid for the work you have done. Not just physical labor, but put to use the knowledge, what you have learnt, studied and wisdom gained through experience.
Make-your-money-work-for-you felt so flimsy, so shallow, that I would shun away, avoid and even reject going towards that thought. I was content with whatever the savings interest and fixed deposits would give at the end of the year and my salary-increment would add some more on top of it and it was all okay. I would read news about inflation, and the money loosing its purchasing power continuously, but that would make me work even more hard so I could save a tiny bit more than what the inflation erodes. I would try to think of new avenues, new ideas, new businesses, innovation that I would work on to be able to create-value and only-then in return expect someone to pay me, not just profit out of thin-air. Not gambling, not speculation, not the profit out of a trade in which someone has to loose for me to win. Not the zero-sum-game. I always preferred the value-addition route for wealth-creation. It was my upbringing of sorts and morals but that story is for another day.
My investment strategy (for a long long time) to double the money, as they say, was to fold it and put it in pocket. And I have benefited by it, only at the cost of opportunity loss. Its only when I think:
- If I could have invested this in a Mutual Fund, I would have __________ amount by now.
- If I could have put this in _______________, my overall portfolio would have been ___________.
that it hurts in retrospect when you think you could have done this or that, but you didn’t know which way. I do not call myself risk-averse. I am not. I am just not get-rich-without-lifting-your-finger type. My grandfather built a business empire from scratch and ran it successfully over his life-time. He was the one I admired. Profits are not ugly. Profits are sweet. Building products, value-creation, generating revenues, giving livelihood to people through jobs, thinking of future strategies to grow, having vendors and customers who love to work with you again and again. None of that is risk-averse.
Only thing I detested was people who would make money out of other people’s earnings. I still cannot imagine that you can sleep easy if the profit you made is based on the loss that was made by someone, somewhere. You can break that loss into smaller chunks and spread it across to more number of people, but the equation does not really change. Gambling, Trading, Stock-Market, Speculation all seemed to be the same to me. I was rather happy with 10 bucks in my hand that grows at 4% and live within my means than all the blood-shed to earn more and more and more and more.
I have loved Physics, loved Mathematics, probability theory, statistics, Bayesian model, Computer science, Embedded systems and Electronics, Microprocessors, making products around them, writing software and firmware. I thought if my skills are needed and valued by others, I can survive and support myself. But after 15 years in the industry and thinking of buying a home, job-loss, falling terribly ill, not be able to work-my-ass-off and ALL other worst-case scenarios I think I needed to change myself. (Not that I would start gambling.)
I thought of at-least “learning” about the stock-market, its principles, its jargon instead of just repelling away from it. I had a small 2-3 years of mutual-funds investments in funds suggested by oh-so-helpful-financial-experts, and that was it, about 8 years ago. Filing returns every-year was such a hassle in itself, so I would stay away from fancy investments just because of the dread of thinking how to report about them in various forms to the government. I was a jerk!
So, I started digging into it bit by bit. Opened a brand new Demat account after looking at various options and commissions and annual fee and offers and what not. Had I been the old person, I would’ve just got lost in analysis-paralysis and then not been able to choose ANY option given the choices and so many permutations and offers. However, this time I didn’t want an “opportunity loss” and I was okay with my choice even if it was less than the perfect or lesser than the best one. At-least, it was the better-one from what I understood and from the information available at hand. Only one mantra helped me, “Until I know better, this is the better”. It is not the end of life. If something is so much better tomorrow, maybe I will switch to that one. And this switching fee, or the loss due to choosing a less-than-the-best-optimized-option might be much less than not choosing at all or waiting until the right opportunity/option or time. Because I chose and having had some experience in using this choice, I can now better evaluate other choices.
Next was understanding how do I pick which stock to buy. There was an IPO, there were equity funds, and then there were so many other things. I would easily be lost in gaining knowledge about “what is what” and again not be able to choose due to so many options, pros and cons, risks & returns. My assigned financial-adviser would call me and tell me about the “market outlook”, ask my “requirement”, suggest some stocks, but I wanted concepts. I wanted to know why I should choose what he suggested me to choose. What is the basis that I should buy a particular share at a price of 50 bucks. So, I would disregard his suggestion. Anyways, I wanted to get the “process-part” through. So I picked a random “good-looking” equity-fund and put a minimum order to be executed when the market opens. I soon got the allocation and it started showing in my portfolio. Similarly, I thought of a name of a renowned company and bought 1 share. That also got transferred in a few days in my account. It was a market-order (something I had to choose rather than giving a “bid” price) and I was happy I didn’t have to call the adviser to go through this step-by-step with him on the phone. It was easy.
I was not satisfied though. So, I was holding 1 share of a particular company. Which would be like ____ % of the total amount of shares that company has. It was an expensive share. Maybe that’s why mutual funds are better, so you can diversify across multiple companies even with smaller amounts. In my mind, I was going back and trying to challenge my decision to open a Demat account. But, what the heck. There are so many other things here, much to learn. So, do I just wait for it to increase in value and that’s it?
I kept looking at other blogs, at Q&A on Quora, at some finance websites and made a list of 20 stocks that people were commenting and suggesting were a good buy at current levels. The “level” keyword is what I wanted to understand. Where is that coming from, how is that derived etc etc.
- A stock worth 200 bucks going to 400 would double the investment.
- But so would a stock worth 5 reaching at 10, given the same investment.
(And I would suppose the latter is easier to expect, but I am just no-one. Not even a novice)
So, I started studying some basic valuation methods and comparing the stock price to company’s financial ratios (P/E, EPS, etc) and I will not detail it here, as I wrote about it already in another post. Things were becoming clear, but I was having even more questions and curiosity (being an engineer). Question that stuck were regarding a “stock market crash”…
- Where does the money go when a stock market crashes?
- Some said it does not go anywhere, because it never was (It was just expectation / speculation)
- Some said it has already gone in the secondary trading.
- Do all stocks go down when there is a crash?
- Is stock-market it a zero-sum-game?
I was not just sitting on the questions, I was rather trying to find the answers where-ever I could on Internet, asking on Quora, reading blogs whenever I would get some time. I collected the following good answers and information:
- Buying a share and investing is actually beneficial as that money is used by the company.
- Anytime a metal/mineral is dug and built into a machine wealth is created, jobs are created, and that is more valuable than the rocks that were dug.
- It is not a zero-sum-game (more on this later)
So it started to feel good that it is not just gambling and anticipating to get more money from whatever you have put in. However, as I dug deeper, more questions started to bother me, like:
- When I buy a share, does the money really go to the company?
- What is the benefit of speculation at all?
- If the shares are traded in the secondary market, what is the value-add to the company?
- Besides an IPO, how does the money get utilized for company’s operations and expansion etc?
These questions were coming from deep-inside of me (if you have read initial paragraphs you know what I am talking about). What is the value-addition I am doing by buying some shares of a company? Is the money even reaching where I think it is? I just bought a share from a trading platform, so the money actually went to the seller of that share, not the company I think I am investing in, neither for its operations or capital or expansion. It was just taken by a seller who was holding this share earlier than I was. And, I would wait and then sell it to another buyer, when I feel right (when I am in profit etc) and even that money will NOT go to the company, it will come to me. So, where is the benefit to the company? What is going on here??
So, I posted a few questions for experts, and found the following, in summary (till now):
- Direct benefit goes to the company only through IPO/FPO and fund-raising.
- Once the stock is listed on exchanges, company does not get anything.
- Henceforth, this is the secondary market where because of speculation among the traders the prices may go up or down. It does not matter intra-day or long-term holding. When you bought in secondary market, you just paid to the seller, not to the company.
- Only the share-ownership change is logged by the company when trade happens in secondary market.
- Offering Rights share also generate money, issuing bonus shares also help company to retain profits, instead of distributing profit by giving dividends.
- The secondary market is also important for the company from a non-monetary view.
- The value of share holding of the company is helping them in there financials (ratings by an agency, raising new capital, getting cheaper loans etc)
- The share price of the company will be high or low based on how the company performing (and it is called Market Capitalization)
- Secondary market helps in “discovering” the “value” of the Company.
- A liquid secondary market provides an Exit Route to the existing investors.
- It forms a benchmark for further raising for funds
Also, it is actually beneficial to the company to buy-back its own shares at a LOWER price than it had sold it, to make a profit. It is counter-intuitive that companies would want their share prices to go higher then. Of course, in light of the benefits of an increased market-capitalization and ratings, it is definitely better for the company that its share prices see newer highs and it does not buy-back.
I was surprised to find senior people who had been investors (and not traders) say to me that in all these years they did not think about this, whether their money actually ever reached or used by the company at all! It was quite shocking to hear that.
In conclusion: I stand here now, with a bit more learning and knowledge, to say it is not just gambling and speculation. There is exponential wealth-creation (not saying everyone is lucky to get that leverage) but both the fund-raising as well as secondary market play a role in helping the company (in their own ways) to raise money for its operations and expansion. Speculation plays a big role and many people do jump into it without much understanding just looking at money-making-more-money principle.
I am actually advised to invest in low-commission well-diversified index-funds, and I used to have a high opinion about them as well as mutual-funds, before I realized that, when you are investing in a company, especially when you are taking an informed decision, not just the herd-mentality, you are actually believing in its vision and its management and giving your money for its growth, for which you will get the returns. In the funds, however, people form large groups of capital (you can call mutual funds or SIPs) for a common-man to invest just for profiteering and money-making without understanding or having any knowledge of array of companies it holds and their functioning. It transforms investment from economic growth oriented to mere money making.
I would like to go ahead and own some more shares that I can keep for my kid. This digging and analysis and writing was enough for today.
Aisde: Just about a day ago I was looking at the Order-book. Yes, its new for me. I actually saw it first-time functioning live on a crypto-currency exchange and was I amazed? Maybe sometime I will write about that too. 🙂
Jagmeet Singh Hanspal is a Software Architect and has worked with various organizations like Ericsson, Juniper Networks, TranSwitch Semiconductors in the field of Telecommunications and Embedded Systems. His interests include Linux, Micro-controllers, Parallel Processing, Networks, Time Synchronization protocols, Data Visualization & Statistical analysis etc. You can find more about him at Author’s personal page.