1. What you will learn
By the end of this lesson you will be able to say what owning a share actually entitles you to, tell the primary market apart from the secondary market and explain who receives the money in each, compute market capitalisation and the effect of new shares on an existing holder's proportionate ownership, and describe the three separate accounts an Indian investor uses. This is education about how shares work and is not advice about any company or security.
2. The idea explained
A share is a claim on whatever is left. When a company earns money it must first pay its suppliers, its employees, its lenders and the tax authorities. Whatever remains belongs to the shareholders, which is why equity is called a residual claim. That is very different from lending money, where the borrower owes a fixed amount whether the business prospers or not.
Owning a share usually carries several distinct things, and they are worth separating because people confuse them. There is a right to vote on certain matters. There is an entitlement to dividends if and when the company declares them, which it is generally not obliged to do. There is whatever the share can be sold for, which changes constantly. And there is the risk of dilution, which is the proportionate stake shrinking when new shares are created.
The two markets are the next distinction. In the primary market a company issues new shares and receives the money itself, which it can spend on the business. In the secondary market, which is what people usually mean by the stock market, existing shares change hands between investors. The company is not a party to those trades and receives nothing from them. This has a consequence that surprises beginners: when a company's share price rises, no money enters the company at all. The price rise benefits the shareholders who own it, not the balance sheet.
Market capitalisation is the simplest and most useful arithmetic in the subject: the share price multiplied by the number of shares outstanding. It is the market's price for the whole equity of the business. Comparing two companies by share price alone is meaningless, because one may have ten times as many shares as the other; comparing them by market capitalisation is at least comparing the same kind of thing.
Dilution follows from issuing new shares. If new shares are created and you do not buy any, you still own the same number of shares, but they represent a smaller fraction of a larger total.
Finally, the plumbing. An Indian investor typically has three accounts doing three different jobs. A bank account holds money. A trading account, opened with a broker, is the route by which orders reach an exchange. A demat account, held with a depository participant, records the securities themselves in electronic form, in the investor's own name at the depository.
3. The market, the regulator and the rulebook
India's securities market has a statutory regulator, the Securities and Exchange Board of India, established by an Act of Parliament, which makes regulations, registers and supervises intermediaries such as brokers, merchant bankers, registrars and depository participants, and acts against fraudulent and unfair practices.
Around it sit the operating institutions. The stock exchanges, principally the National Stock Exchange and the BSE, run the electronic platforms on which shares are bought and sold. The clearing corporations step between buyer and seller after a trade to manage the resulting obligations. The depositories, the National Securities Depository Limited and the Central Depository Services Limited, hold shares in dematerialised form, and a depository participant is the intermediary through which an investor opens and operates a demat account.
Listed companies publish quarterly results, annual reports and disclosures of material events, on their own websites and on the exchanges'. Before interpreting any price you see, establish its timestamp, the exchange it came from, and whether the series has been adjusted for corporate actions such as splits and bonuses. Never quote a brokerage rate, transaction charge, tax rate or settlement timetable from memory; find where it is currently published and note the date.
Worked example
4. Worked example
All figures are invented and the company does not exist. A fictional company has ten lakh shares outstanding and its shares trade at eighty rupees.
Its market capitalisation is ten lakh multiplied by eighty, which is eight crore rupees. That is the market's price for the whole of the company's equity, not the price of one share.
An investor holds ten thousand of those shares, which is ten thousand out of ten lakh, or one per cent of the company.
Now the company issues two lakh new shares. The total becomes twelve lakh. The investor, who bought none of them, still holds ten thousand shares, but now that is ten thousand out of twelve lakh, which is about zero point eight three per cent. Her holding did not shrink; the denominator grew.
Now suppose instead the company had issued five lakh new shares. The total would be fifteen lakh, and her ten thousand shares would be about zero point six seven per cent.
Two cautions about this arithmetic. First, it says nothing about what the share price becomes, because that depends on what the company received for the new shares and what it does with the money.
Finally, the money. If the company sold those two lakh shares at eighty rupees each, it received one crore sixty lakh rupees into its own account. If instead an existing shareholder had sold two lakh of his own shares to other investors, the company would have received nothing at all, because that is a secondary market transaction.
5. Common mistakes and how to fix them
The first mistake is comparing companies by share price. Multiply by the share count and compare market capitalisation instead.
The second is believing a rising price puts money into the company. It does not, unless the company issues shares.
The third is confusing the three accounts. Money sits in the bank account, orders travel through the trading account, and shares are recorded in the demat account at a depository.
The fourth is treating a dividend as guaranteed. It is declared at the company's discretion, and there is no obligation comparable to a lender's interest.
The fifth is reading a price without its context. Note the timestamp, the exchange and whether the series is adjusted for corporate actions. Past performance does not indicate future results, no share is safe or guaranteed, and a SEBI-registered investment adviser is the person to consult about an individual's own money.
Key takeaways
6. Board summary
A share is a residual claim, paid after everyone else, with no promise of repayment. The primary market gives money to the company; the secondary market moves existing shares between investors. Market capitalisation is price multiplied by shares outstanding, and it is the only fair basis for comparing two companies' size. Issuing new shares dilutes a non-subscribing holder's percentage, though not the number of shares she owns. Bank account holds money, trading account routes orders, demat account at a depository records the shares.
Check your understanding
7. Practice and self-check
One. A company has twenty lakh shares at one hundred and twenty rupees. Market capitalisation? Twenty-four crore rupees.
Two. An investor holds forty thousand shares. What percentage of the company is that? Two per cent.
Three. The company issues five lakh new shares and she buys none. Her new percentage? Forty thousand out of twenty-five lakh, which is one point six per cent.
Four. Did she lose any shares? No; the denominator grew.
Five. Company A trades at fifty rupees and Company B at five hundred. Which is larger? Cannot be said without the share counts.
Six. A share price doubles on the exchange. How much money does the company receive? None.
Seven. Which account records the shares themselves? The demat account at a depository, operated through a depository participant.
Eight. The company sells five lakh new shares at one hundred and twenty rupees. What does it receive? Six crore rupees, before issue expenses.
Nine. What three things must you establish before interpreting a quoted price? Its timestamp, its exchange, and whether it is adjusted for corporate actions.