The intent of this post is to explain Stock Trading in simple words.
Let’s start with the story of Sharma Ji, a fruit juice shop.
Sharma Ji earns by selling fruit juice in his chota hathi near a jogging park. He keeps his stocks of fruits and hand-operated juicer machine in his chota hathi. Every morning he buys fruits from a wholesale shop and puts it in his chota hathi. He manages to sell approximately 100 glasses of juice every day, priced at 20 Rs. per glass. Thus his total revenue comes to 2,000 Rs. per day or 60,000 Rs. per month. His total expense comes around 40,000 Rs per month towards buying fruits, paying EMI for chota hathi, etc. Thus Sharma Ji effectively earns 20,000 Rs per month through this small business.
Sharma Ji sees a good future in this business and plans to expand it by renting a shop and purchasing an electronic Juice machine. Also, he would hire a person to help him during the busy hours of the day. The challenge is that he doesn’t have enough money or let say the capital for his plans. So he contacts a few of his friends and relatives to invest in his business. He explains them the business and his future plans to expand the business. Luckily he manages to convince two of his friends to raise capital(money).
Sharma Ji raises 1 Lakh each from his two friends and promises them good returns when his business grows. He invests this amount towards a new rented shop, furniture, juicer machine and hiring a helper. Also, he increases the price of juice to 25 Rs. per glass. This transformation indeed grabbed the attention of customers and his sale got twice to 200 glasses per day. So his monthly revenue became 1.5 Lakh. After paying the expenses towards fruits, rent and helpers salary his net profit comes to 60,000 per month or 7,20,000 per year. Good money, isn’t it?
Now the question is how would the investors (two friends) profit from this deal? When Sharma Ji took money from his friends he signed an agreement to give them 5% of his total profit amount each year. This calculates to 36,000 Rs. Also, Sharma Ji would allow investors to withdraw money from his business at their will. The amount withdrawn would depend on the market value of the business at that time. As Sharma Ji’s business grew further, more investors would be attracted towards it and he could open multiple shops in the town.
Now let’s see this situation Share market terms:-
- Sharma Ji and his fruit juice shop is similar to a company which wants to raise money from investors or in other words the company which is registered in Stock exchange like National Stock Exchange (NSE) or Bombay Stock Exchange (BSE).
- Sharma Ji’s are friends is similar to shareholders of his company who invests in it with the prospect of making money.
- Sharma Ji estimated the net initial worth of his company as 10 Lakhs and offered 1,000 shares worth Rs 1,000 each. His friends purchased 100 shares each, at the price of 1,000 per share. So, their individual investment is 1 lakh. Once they purchased these shares, they would be legal Shareholders of Sharma Ji’s company.
- Sharma Ji offers 5% of the net profit to its investors every year. In share market terms this is called dividend and offered as a fixed amount per share.
- As Sharma Ji’s company grows, it's market capitalization would increase which in turn would increase the price per share. Every investor would benefit from this increase in the share price. Below is the formula for calculating Share Price.
Share Price = Market Capitalization / Number of Shares Outstanding in Market
- As Sharma Ji’s company grows, more and more investors would be attracted to buy its shares, which in turn would help Sharma Ji to expand his business.
- Sharma Ji carried out all these share transfer and selling transactions privately without the involvement of any regulating authority.
- In the real world, such transactions are carried out in stock exchanges regulated by authorities like SEBI. Companies can list their shares in exchanges (NSE/BSE) and investors (Like You and Me) can buy it.
Please feel free to leave a message if I can help you further or you see an improvement here.