How to make money in the Stock market(continued from last post)
Welcome back. If you have not read part 1, I advice you do so.
In the course of this series, I will be discussing time-tested strategies to make a fortune in the stock market but I want to devote today’s write-up to explain concrete ways investors make money in this specialized market.
1. Capital Appreciation: This happens when the price of a stock an investor bought rises and the investor decides to sell all or part of his holding in that particular stock. For example if you buy stock of GTB at N15 per share and over time it rises to N25, you would have made a capital gain of N10 on each share. If you bought 10,000 shares for N150,000 the stock would then be worth N250,000. If you decide to sell at that point, you would have made a gain of N100,000 on your investment of N150,000. In percentage terms that is a gain of 67%.
Now such dramatic increase in price can happen sometimes within a few days or weeks. Sometimes it may take months or years. It all depends on how well the company is performing as well as other variables of market forces, government policies, perception of foreign investors, etcetera.
We will be discussing many of these factors in subsequent parts of this series. Let me just say it is not a wise strategy to attempt to time the market, that is buying when one thinks the price of a stock is low and quickly selling when it rises.
The fault in this approach lies in the fact that a stock you think has fallen in price may fall even further after you have bought thereby incurring a loss for you, although in real terms, you don’t incur that loss until you sell the stock, at which time the money you will be getting will be less than the amount you invested.
On the other hand if you sell because you think the price has risen enough and you have made say the 67% gain we mentioned earlier on, you may be dismayed watching the price of the stock rising further after you have sold to give those who were patient even up to 300% again.
Tell me you will not blame yourself for rushing to sell!
To some extent, professionals are able to time the market correctly some of the time but it is foolhardy for amateur investors to attempt do so. It will amount to gambling. You will lose more than you gain.
A better approach is to adopt the investor method, going for medium to long term on any stock. That is to say when you see a good opportunity (I will tell you in subsequent series how to recognize them), you buy the stock and wait like the vulture which is a patient bird.
Over time you will see the stock price rise and fall and you then have an idea of its range: That is the lowest price it drops to and the highest price it swings to. Now, if there is new information from the company to the market about a new product or technology or acquisition of a new business or recruitment of a world renowned expert to run the company, the market will respond positively and the price will start climbing.
Or if the company announces a bumper profit made in the course of the trading year and it is giving out generous dividends and or scrip issue (Bonus shares) you can be sure the price will shoot through the roof. It will not always remain there.
Once the euphoria wanes and or the benefits are paid out to shareholders, the price will drop again, significantly, though it may not return to the old price unless some negative news within the company or in its operating environment come to play.
So having stocked the shares of such company at a calm period and this kind of opportunity comes; you see a stock you bought at N10 shooting to N30 because of such positive development, it will be wise to sell and lock in your profit.
That would mean a gain of 200%. When the price comes down again to around N15 you can buy back the entire volume you sold and still have not less than 150% profit to improve your life with.
2. Scrip Issue: Usually companies do not give out all the profits they make in any financial year as dividends to shareholders. They always hold a part of it back as reserves in their accounts. Over the years this reserve grows.
At one point or the other the company may need to put part of this reserve to work either for setting up a new factory or acquiring modern machinery to improve production or to buy more distribution vehicles or to buy over another business or a combination of any of the above.
Since the money in the reserves belong to the shareholders in proportion to their shareholding, it is mandatory that owners of the money approve such intention by the company. This is done at the annual general meeting which holds once a year or the board of the company may summon an extra ordinary meeting of shareholders to get needed approval. To get such approval the board will detail how much is needed to be capitalized, (i.e. turn to trading capital) and what proportion it is to existing capital contributed by the shareholders that is already in use.
For example if the company’s paid up capital is N100 million and they want to take another N100 million from the reserves, it means they want to double the capital employed in the business. For shareholders to have evidence of their money that is now being put to work, the company issues scrip or bonus shares to its shareholders.
Since the amount being taken is equal to the amount already in use, it means each shareholder’s investment has doubled! One new share will be issued for every share already held. So if you have 100,000 shares, you will be given another 100,000 shares without bringing any additional money.
That brings your holding to 200,000 shares. All the shares will have the same value and tradability. You can do with it whatever you like. If you sell the new 100,000 shares, you would have recovered your total investment in the company and yet what you invested originally is still there INTACT!
3. Dividend: Many shareholders are not too excited by this one. It is their own share of the profits paid out annually or bi-annually (twice a year) by companies. They are not excited by it because it is usually small, although that is because most investors are small-time investors. In the nineties, the benchmark of a profitable company was one that paid dividends consistently and whose dividend payout was at least 10% of its share price.
So a stock that was selling for N1 then must pay at least 10k per share to be considered profitable. Now, to a small-time investor holding just 1000 shares, this amounted to N100, then there was 10% withholding tax that was deducted at source for government, so he gets N90 as his share of the profit for investing N1000 for one year. But imagine someone who invested one million naira and had one million shares. His own dividend would be N90,000. In the nineties that would buy you a clean Panel Van car that was reigning among young graduates then!
So dividend was considered as lunch money! Shareholders called it kobo-kobo payment! But at 10%, it was still a higher return than what was paid on savings account. So instead of keeping money in savings, it still made sense to invest in stocks of solid, profitable companies when one considered the added benefits of scrip issue and capital appreciation windfalls that came every now and then.
To be continued…….
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