We saw in the previous posts that the premium is the extra money that the public is willing to pay. Suppose I am an umbrella seller.. (Haha.. I am an entrepreneur!! ) In autumn or spring, the demand for my umbrellas is less and I would probably sell it at cost price, or a minimum profit. But in the rainy season, I can sell it at a upto 20% above its cost, because it would sell anyway. This difference between the actual price and the actual value is called a premium.
If my company / sector is doing well, people will be willing to spend more on my company, ie they are willing to pay extra (a premium) to get my shares. Now, one of the primary things a company does, when it goes for a public issue (ie raising money from the public by shares) is to determine its share price. The share price (the exact number) is generally determined by SEBI (Securities and Exchange Board of India, a regulating body of the Indian Govt. ) by:
1) Fixed price process
2) Book building process.
Though the exact price may be determined by the above processes, the company specifies a price range for its shares. That is, it specifies a range a range between which the actual price may fall.. i.e. if the band specified is from Rs.690 to Rs. 750, my prices can vary in that range only. So, how is this price band determined?
The price band is determined by the valuation of the company. This valuation is a pretty complex process and is done by the CFO (chief financial officer) with his team, or sometimes by banks like ICICI, Kotak Mahindra etc. There are a lot of ways of valuing a company, but it predominantly depends on the market forces.
Assume that I own a cement company (I can expand from umbrellas to cement u know.. it’s a cake walk!! ) that’s going public, to build a new plant in Orissa. Since India’s GDP is growing at a staggering 8% or more, it is logical to assume that a lot of infrastructural developments will take place. If infrastructure is growing, that means cement will do well. Hence, people will be ready to invest in the cement sector. Hence, my cement company can have a high price band and still be sold.
On the other hand, after the Reliance Power IPO, the public would not be ready to invest in the power sector, at least for some time. Hence, any power company that’s thinking of a public issue would have to price its shares lower to attract investors.
The price band may also be fixed on the basis of the other share prices in the sector. For ex, I can fix my price (Remember the cement company I own?? ;) ) on the basis of the share price of other cement companies.
If my cement company has a brand image of its own, (like the TATA’s, Ambani’s or the TVS group) my pricing may be in a different band altogether. It may not be comparable to my peers, because the public trusts me and my brand. They are ready to pay more to acquire a share in my company!! (How I wish!!)
There are a lot of other ways also, in which the price band may be determined, but let’s leave them to the companies. We will see the method of fixing the exact price, at a later stage. Cya..
Monday, March 31, 2008
Thursday, March 27, 2008
Judging a book by it's cover? No no no...
In the world of stock markets, there are two things that you will find in plenty. One is the money. The second is the list of technical terms used. Most of the terms tend to confuse the common man (i.e. people like me & Niranj). Let’s try to unravel the mysteries, one at a time..
One of the predominant jargons we come across is the difference between a "face value" and a "premium" of a share. Take a 100 Rupee note for instance. We tell that the value of the note is 100 because of the number printed on it. This is called Face Value - i.e. the actual value of the item in consideration. The same 100 rupee note after several years becomes very valuable in the hands of an antique collector and sells for Lakhs /millions. The difference between the actual value ( 100/-) and the actual price is called the premium.
Bringing this analogy to shares, the actual value of the share is called the face value (FV). That is, the actual contribution made by the person towards the company is equal to the face value. The face value of a share is generally Rs 10/-. There are also shares that have a face value of Rs2/- and face value of 100/-. Further, all the profits that are allotted to a shareholder are also based on this value. For ex, a 200% dividend on a share (with FV Rs 10) implies a dividend of Rs 20/ share.
When a company plans to do an IPO, ie Initial Public offering (another jargon ;) ), it determines the Face value and the Premium at which it plans to sell the shares. The premium and the face value of the shares are usually different. This is due to two reasons.
1) The company needs to generate a said sum of money within a given number of shares.
2) The company believes that its shares are worth the specified premium and people will buy the shares at the specified price.
Note that though the shares are “actually” worth only the face value, they are usually bought and sold at a much higher value – courtesy, the premium. This is because of the valuation of the company. In simple words, the market and the investors believe that the company will continue to run well and achieve results. More the belief more is the demand for the company's shares, and thus a higher premium. Further, the difference between the FV and premium will be treated as capital, meaning that it cannot be returned to the shareholders by way of a dividend.
You might have noticed the use of another “technical” term – IPO . The IPO is the process by which the company enters the stock market, and sells its shares to the public. This is also referred to as ‘going public’. While raising money is one of the primary reasons for a company to list its IPO, there are other advantages also. These advantages along with the process of IPO form the content of the next blog. Keep looking.... :)
One of the predominant jargons we come across is the difference between a "face value" and a "premium" of a share. Take a 100 Rupee note for instance. We tell that the value of the note is 100 because of the number printed on it. This is called Face Value - i.e. the actual value of the item in consideration. The same 100 rupee note after several years becomes very valuable in the hands of an antique collector and sells for Lakhs /millions. The difference between the actual value ( 100/-) and the actual price is called the premium.
Bringing this analogy to shares, the actual value of the share is called the face value (FV). That is, the actual contribution made by the person towards the company is equal to the face value. The face value of a share is generally Rs 10/-. There are also shares that have a face value of Rs2/- and face value of 100/-. Further, all the profits that are allotted to a shareholder are also based on this value. For ex, a 200% dividend on a share (with FV Rs 10) implies a dividend of Rs 20/ share.
When a company plans to do an IPO, ie Initial Public offering (another jargon ;) ), it determines the Face value and the Premium at which it plans to sell the shares. The premium and the face value of the shares are usually different. This is due to two reasons.
1) The company needs to generate a said sum of money within a given number of shares.
2) The company believes that its shares are worth the specified premium and people will buy the shares at the specified price.
Note that though the shares are “actually” worth only the face value, they are usually bought and sold at a much higher value – courtesy, the premium. This is because of the valuation of the company. In simple words, the market and the investors believe that the company will continue to run well and achieve results. More the belief more is the demand for the company's shares, and thus a higher premium. Further, the difference between the FV and premium will be treated as capital, meaning that it cannot be returned to the shareholders by way of a dividend.
You might have noticed the use of another “technical” term – IPO . The IPO is the process by which the company enters the stock market, and sells its shares to the public. This is also referred to as ‘going public’. While raising money is one of the primary reasons for a company to list its IPO, there are other advantages also. These advantages along with the process of IPO form the content of the next blog. Keep looking.... :)
Saturday, March 22, 2008
Stock Markets - A Preamble
Ever wondered what a stock market is? What a share is? How the share number and its price causes “blood baths”,” bear hugs” and “bull run”? What it means to whom when the share value changes? What does the company gain out of it? As engineers, me (Niranjana) and Renga have always wanted to know what shares are. How they affect the life of a company and how they affect the life of the common man…..
This amateur venture is to pen our thoughts down, as we understand it. Please post your thoughts/comments/suggestions after reading this. :)
Shares are actually a means of raising money for a company. Assume that Anil Ambani wants to start a company. (After the Reliance Power fiasco, he is a lil’ quiet now, but we can safely predict that he will be back to form). He needs a total of Rs. 5,00,000 to start this company. How can he get this money?
1) He can fund it himself
2) He can ask his friends / family ( brother Mukesh too ;) )
3) He can take a loan from a bank
4) He can go to a venture capitalist (More about Venture Capitalists later....)
5) He can go to the public
Now, stock markets are concerned with point no 5, i.e. going to the public. What do you mean by going to the public? Anil can raise money from the public and give them what is called a share certificate instead.
Let’s see what it means. He can take Re1 from 5,00,000 people and give them 5,00,000 shares. Then the company is owned by all the 5,00,000 people who buy those shares. These “shares” are generally referred to as stocks.
Then, what do the people get in return? They get what is called a dividend, that is; a portion of the profit earned by the company. The dividend is generally given on a per-share basis. Say, if the new company earns Rs.10,00,000, each shareholder will get Rs.2 / share.
But, if the company wants to go for further expansion and requires Rs. 5 lakhs, for that, it may choose to retain that amount from the profit and distribute the balance 5 lakhs at Re.1/share. This dividend amount is decided at the annual general body meeting (AGM).
At the AGM, if a simple majority of shareholders agree that the profits can be ploughed back for further expansion, then the company invests the 5 lakhs, else it has to distribute the profits as dividend. Thus the shareholder enjoys voting rights, because he/she is the owner of the company.
Now, consider this. If Anil sells all the shares of the company to the public, then he will have no control over the company. Hence, the owners generally own a portion of the shares and give the rest to the public. They hold on to 76% or 51% (sometimes 26%) of the shares and sell the rest of the shares to the public. This enables them to maintain a hold / control over their company.
The owners are also called as promoters. In our case, let’s assume that the promoter Anil holds on to 51% of the shares. The rest can be raised from the public, or some company can buy them too. For instance, TCS (a leading software company) can buy 26% of the shares and the rest 23% can be given to the public.
What’s the face value of a share? What’s a premium? These questions will be answered in the next few blogs.
This amateur venture is to pen our thoughts down, as we understand it. Please post your thoughts/comments/suggestions after reading this. :)
Shares are actually a means of raising money for a company. Assume that Anil Ambani wants to start a company. (After the Reliance Power fiasco, he is a lil’ quiet now, but we can safely predict that he will be back to form). He needs a total of Rs. 5,00,000 to start this company. How can he get this money?
1) He can fund it himself
2) He can ask his friends / family ( brother Mukesh too ;) )
3) He can take a loan from a bank
4) He can go to a venture capitalist (More about Venture Capitalists later....)
5) He can go to the public
Now, stock markets are concerned with point no 5, i.e. going to the public. What do you mean by going to the public? Anil can raise money from the public and give them what is called a share certificate instead.
Let’s see what it means. He can take Re1 from 5,00,000 people and give them 5,00,000 shares. Then the company is owned by all the 5,00,000 people who buy those shares. These “shares” are generally referred to as stocks.
Then, what do the people get in return? They get what is called a dividend, that is; a portion of the profit earned by the company. The dividend is generally given on a per-share basis. Say, if the new company earns Rs.10,00,000, each shareholder will get Rs.2 / share.
But, if the company wants to go for further expansion and requires Rs. 5 lakhs, for that, it may choose to retain that amount from the profit and distribute the balance 5 lakhs at Re.1/share. This dividend amount is decided at the annual general body meeting (AGM).
At the AGM, if a simple majority of shareholders agree that the profits can be ploughed back for further expansion, then the company invests the 5 lakhs, else it has to distribute the profits as dividend. Thus the shareholder enjoys voting rights, because he/she is the owner of the company.
Now, consider this. If Anil sells all the shares of the company to the public, then he will have no control over the company. Hence, the owners generally own a portion of the shares and give the rest to the public. They hold on to 76% or 51% (sometimes 26%) of the shares and sell the rest of the shares to the public. This enables them to maintain a hold / control over their company.
The owners are also called as promoters. In our case, let’s assume that the promoter Anil holds on to 51% of the shares. The rest can be raised from the public, or some company can buy them too. For instance, TCS (a leading software company) can buy 26% of the shares and the rest 23% can be given to the public.
What’s the face value of a share? What’s a premium? These questions will be answered in the next few blogs.
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