Before investing, it is important to conduct research and develop an understanding of certain basic concepts. When learning the basics of stock trading, there are a few essential terms to know and they are as follows:
What is Equity (Shares)?
Equity represents ownership in a company, and it’s divided into smaller, equal parts called shares. For instance, if a company has equity capital of ₹2 crore (₹20,000,000) split into 20 lakh (2,000,000) shares, each share is worth ₹10. Owning a share means being a part-owner of the company, with the right to vote on important company decisions.
Warrants
A warrant is a certificate that comes with a bond or preferred stock. It gives you the right to buy a specific number of company shares at a fixed price in the future.
Convertible Debentures
Convertible debentures are loans (debt) that can be turned into company shares at a later date. This conversion is based on conditions agreed upon by either the company or the lender. Companies use this option to borrow money at a lower interest rate since lenders also get the benefit of converting the debt into shares later.
Rights Issue (Rights Shares)
This is when a company offers new shares to its existing shareholders. The shareholders can buy these shares at a discounted price in proportion to their current holdings. For example, in a 2:3 rights issue at ₹125 per share, you can buy 2 shares for every 3 shares you already own, at ₹125 each.
Bonus Shares
Bonus shares are extra shares a company gives to its shareholders for free. The number of bonus shares you get depends on how many shares you already own. It’s like a reward from the company to its investors.
Cumulative Preference Shares
Cumulative preference shares are a special type of stock. If the company misses paying dividends in any year, these unpaid amounts are carried forward. Shareholders with these shares are paid all the accumulated dividends before any dividends are given to regular (equity) shareholders.
Cumulative Convertible Preference Shares
These shares come with two features:
1. Cumulative dividends: If the company cannot pay dividends in a year, the unpaid
dividends will roll over to the next year(s).
2. Convertible: After a certain date, these shares are converted into regular equity shares
of the company.
IPO (Initial Public Offer)
This is the first time a company offers its shares to the public for investment, helping the company raise money and allowing people to become shareholders.
Public Issue
Any time a company offers its shares to the public for investment, it’s called a public issue.
Bonus Shares
A company gives free extra shares to its existing shareholders in proportion to the shares they already own. For example, for every 10 shares you own, the company might give you 1 bonus share for free.
Rights Issue
The company offers new shares to its existing shareholders, but unlike bonus shares, you have to buy these at a discounted price. For example, for every 5 shares you own, the company might let you buy 2 more shares at a lower cost.
GDR / ADR (Global Depository Receipt / American Depository Receipt)
These are ways for a company to let international investors buy its shares.
• GDR: Shares are traded on international stock exchanges outside the U.S.
• ADR: Shares are specifically traded on U.S. stock exchanges.
Each of these represents a fixed number of shares listed on the local stock exchange.
Buyback
When a company repurchases its own shares from the existing shareholders, either through a public offer or by buying them in the stock market, it’s called a buyback. This often helps the company reduce the number of shares available and improve its stock value.
Face Value (Nominal Value or Par Value)
This is the original price of a security set by the issuer.
• For shares: It’s a small amount like ₹5 or ₹10 printed on the share certificate. The
actual trading price in the stock market is usually much higher, such as ₹100 or ₹1,000,
depending on demand.
• For bonds: It’s the amount paid back to the investor when the bond matures. For
example, most government or corporate bonds have a face value of ₹100. The bond's
market price fluctuates based on interest rate changes.
Dividend
A dividend is a portion of a company's profits that it gives back to its shareholders, usually as a percentage of the face value of the share. For example, if a company declares a 10% dividend on a ₹10 face value share, the shareholder gets ₹1 per share. Over time, equity investments can provide the highest returns compared to other forms of investment.
Market Capitalization (Market Cap)
Market capitalization is the total value of a company’s shares traded in the stock market.
Formula:
Market Cap = Total Number of Shares × Current Market Price (CMP) of Each Share.
For example, if a company has 1 crore (10 million) shares, each trading at ₹50, its market cap is ₹500 crore.
Enterprise Value (EV)
Enterprise value shows the total cost to buy the entire company. It’s considered more accurate than market capitalization because it includes other factors like debt and cash.
Formula:
Enterprise Value = Market Cap + Preference Shares + Debt – Cash & Cash Equivalents.
It gives a fuller picture of a company’s worth if someone wanted to acquire it.
Intrinsic Value
Intrinsic value is an estimate of the true worth of a business. It’s based on the discounted value of all the cash the business is expected to generate in the future. Since this involves assumptions about future earnings and interest rates, the intrinsic value can vary depending on who calculates it. It’s not an exact number but more of a well-informed guess.
Beta
Beta measures how much a stock’s price moves compared to the overall market.
• Beta < 1: The stock is less volatile than the market (e.g., consumer goods or utility
companies).
• Beta > 1: The stock is more volatile than the market (e.g., cyclical or industrial
companies).
For example, if the market moves by 10% and a stock with a beta of 1.5 moves by 15%, it shows the stock is more sensitive to market changes.
Book Value (BV)
Book value represents the net worth of a company based on its recorded assets and liabilities. It’s especially useful for valuing banking stocks or companies with significant assets like land.
Formula:
Book Value = Shareholders' Funds ÷ Total Number of Equity Shares.
However, it’s less relevant for evaluating companies in fast-growing industries like technology, where intangible assets and growth potential are more important.
Debt-to-Equity Ratio (DER)
This measures how much long-term debt a company has compared to the money invested by shareholders.
Formula:
Debt-to-Equity Ratio = Long-Term Loans ÷ Shareholders’ Funds.
• A high ratio means the company relies heavily on borrowed money, which is riskier for
investors.
• A low ratio means the company uses more of its own funds, making it safer.
• Bank debt vs. bond debt: Companies prefer bonds because bank loans can be recalled
at any time. Paying off bank loans often leads to better valuation (higher price-to- earnings ratio or PE expansion).
Dividend Yield (DY)
This shows how much a company pays in dividends compared to its stock price.
Formula:
Dividend Yield = Dividend per Share ÷ Market Price per Share.
• A high dividend yield attracts new investors, especially when stock prices drop, as
dividends become more valuable.
• Dividend-paying companies are a favorite of value investors and tend to be more stable
during economic downturns.
• When choosing dividend-paying stocks, look for companies with a reliable history of
paying dividends even in tough times.
Discounted Cash Flow (DCF)
DCF calculates the present value of all future free cash flows a business is expected to generate.
• Companies with large capital expenditure projects often have lower free cash flow,
which can reduce their valuation.
• Higher interest rates increase the cost of borrowing and reduce valuations.
• DCF works best for stable companies, as it’s harder to predict cash flows for fast-
growing businesses.
Earnings per Share (EPS)
EPS tells you how much profit a company makes for each of its shares.
Formula:
Earnings per Share = Net Profits ÷ Number of Equity Shares.
• On its own, EPS doesn’t say much. It’s more useful when compared to the stock price
(like in the Price-to-Earnings ratio).
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