The stock market is a place where you can buy and sell shares of stock of a publicly listed company. There are four key terms in that definition, which I will elaborate:

  • A Place: It’s a place called the Philippine Stock Exchange or PSE. They have two offices – one in Ortigas and one in Makati. But we don’t need to go there in order to transact with them.
  • Buy and Sell: That’s why it’s called a stock “market”. There are only select representatives called Trading Participants (or brokers) who can directly buy and sell shares of stock, though. For individual investors, we just transact with these brokers.
  • Shares of Stock: Stocks, shares of stock, or shares (all used in the same way) represent ownership of a company. In a sole-proprietorship there is just one share of stock owned by the founder of the company. In corporations, there are multiple shares which can be owned by many different people. These are the shares which are bought and sold in the stock market.
  • Publicly-Listed Company: Not all corporations are available in the stock market. The corporation must be a publicly listed company. A publicly-listed company is a business that offers its shares of stock to the public. This is usually done in order to finance its expanding operations. Now because the general public can invest, the company must first pass strict standards set by the PSE.

So to recap on what the stock market is just 4 things:

  • (1) It is a place where
  • (2) you can buy and sell
  • (3) shares of stock of
  • (4) publicly listed companies.

Why Trade In Stock Market

  • You do not need a lot of money to start making money, unlike buying property and paying a monthly mortgage.
  • It requires very minimal time to trade - unlike building a conventional business
  • It’s ‘fast’ cash and allows for quick liquidation (You can convert it to cash easily, unlike selling a property or a business).
  • It’s easy to learn how to profit from the stock market.

But You need to have your basics clear. Unless you do….you will be wasting your time and loosing money. You need to be crystal clear of each and every aspect of Investments, stock options, Stock Trading, Company, Shares, Dividend & Types of Shares, Debentures, Securities, Mutual Funds, IPO, Futures & Options, What does the Share Market consist of? Exchanges, Indices, SEBI , Analysis of Stocks – How to check on what to buy?, Trading Terms (Limit Order, Stop Loss, Put, Call, Booking Profit & Loss, Short & Long), Trading Options – Brokerage Houses etc.

How does the stock market work?

There are three interactions between the four groups of people that make the stock market work. In the diagram below, we are the “Investors” and we only deal with the “Trading Participants”.

However for a complete understanding of the market, I’ll briefly describe the other relationships.

  • The Publicly Listed Company and the PSE - The publicly listed company applies to the PSE so that they can be allowed to offer shares of stock to the public. The company must comply with very stringent requirements before the investments are opened to the public. The PSE protects you, the investor, and safeguards your interests.
  • The PSE and the Trading Participant (Broker) - The PSE does not directly transact with us investors. Only Trading Participants licensed by the SEC are allowed to buy and sell shares of stock. This was done simply for control purposes and work simplification. The PSE prioritizes monitoring of Publicly Listed Companies while the Trading Participants deal with the investing public.
  • The Trading Participant and the Investor (You!) - You will have to contact a trading participant or broker if you want to buy or sell shares of a particular company. For this, the broker will charge a very small fee for the buying or selling transaction. Brokers also provide you with information on which companies are good to buy in addition to their transaction services.

So in summary, this is how the Stock Market Works: (1) The PSE monitors and screens companies who would want to become publicly listed. (2) The PSE assigns trading participants to interact with the public for the buying and selling of shares. (3) The trading participants become the middle man between the PSE and the investing public.

How do I make money in the Stock Market?

Remember that in the stock market, you’re buying ownership of businesses. So you make money the same way its business owners make money. These are through dividends and capital gains.

Dividends

The dividends are your share of earnings in the company as an investor. For example, last May 2012, the company, FPH (First Philippine Holdings) declared a dividend to be distributed among its shareholders. Each shareholder was to receive PhP1 per share. At that time I had 1,340 shares of FPH. This means I earned PhP1, 340 from my investment in FPH.

A common question that is asked here is that “why would the company declare dividends?” The answer to that is simply because they are also shareholders of the company. So in effect, by declaring dividends they are also paying themselves.

Capital Appreciation or Capital Gains

The second way is through capital appreciation. This simply means that company you own is worth more than when you bought it. For example, in January 4, 2010 a share of FPH costs Rs 46.50. Two years later, the price of FPH was already Rs 61.50 – a difference of Rs 15 or 30%. So if you bought 100 shares of FPH, you could have made Rs 1, 500.

How much money can I make in the stock market?

The amount of money you can gain or lose in the stock market is always a percentage of the amount of money you put in. How high or low this percentage is dependent on how willing you are to learn and how disciplined you are in applying what you learn. Now, before I give you the numbers, it’s important that you understand that a high percentage and a low percentage is often compared to the market average.

For instance, in the year 2011, I gained 30%. I personally think that this is just average given that 2011 was a very good year. In fact, in one of the seminars I was attending, the professor asked one of the audience members how much money he made in his stock trading, he answered 100%. He doubled his money in just a year! Amazing!

However, if we were in the year 2008, during the time of the financial crisis, the average return was negative! So if an investor made a profit, his performance was already considered above average.

Here’s a graph of the Philippine Stock Exchange index (PSEi) for the past 5 years. This PSEi graph is useful because it is often used as a benchmark on how the market performed. As you can see, the PSEi was going down the whole year of 2008.

How much money do I put in the stock market?

The kind of money that the average investor should put in the stock market is money that he or she won’t be needing today, tomorrow, next year, or even 5 to 10 years from now. This is because you can never exactly predict what the value of your investment will be in the coming years. So even though the average annual return on the stock market (from 1999 to 20016) was 14% per year, future returns are never guaranteed.

The Biggest Problem in Investing

The biggest problem that can arise with investing is when your personal situation forces you to suddenly sell your investments for cash when the market is down.

Let’s take the story of Mark as an example. Mark invested all his savings – amounting to Rs 100, 000 – in the stock market. He hoped that someday he’d use it as down payment for a house. Unfortunately, he got into an accident where the bones in his leg got crushed. The medical fees were Rs 100, 000. And even though his company offered medical benefits, his employer would only pay for Rs 20, 000. So Mark had to find a way to pay for his share of P80, 000. The only other place he had money was in the stock market.

Unluckily, at that time, the market was down and the value of his investment was just Rs 80, 000. That didn’t surprise him, because it had already happened in the past. The value would go down and then it would go up again. It would go down and then it would go up again. Normally, he would just wait it out.

But this time was different. He couldn’t afford to wait for his investment to go up. He had to pay the hospital. So, he withdrew his investment worth Rs 80, 000, taking a loss of Rs 20, 000. This is one of the most discouraging things that can happen when you put all your money in the stock market.

Make sure this doesn’t happen to you!

In order to prevent the problem above, there are three ways to protect your investments from a sudden need of cash. I recommend that you do all of them, before you invest in the stock market.

  1. Protect yourself with insurance. This is to make sure that when an accident happens (to you, your loved ones, your car, home, or business) it will be the insurance company that will be obligated to pay for it. At the same time, you won’t need to cash out on your investments.
  2. Shield yourself with an emergency fund. An emergency fund is a sum of money set aside just for emergencies. The general minimum of this amount is 6 months of your living expenses. This is for the unexpected things in your life which can’t or won’t be covered by insurance. So if you suddenly need money because you lost your job, you can live off your emergency fund until you find a new one.
  3. Only put in money you won’t be using for the next 5 years. In order to be able to do this, you should have a good grasp of the amount of money you’ll be using. Don’t forget to factor in the once a year expenses like birthdays and holidays. When the 13th month pay isn’t enough to cover for your Christmas expenses, it would be very tempting to cash in on your investments.

Purchasing Securities in the Primary Market

Initial Public Offering (IPO)

Is when a hitherto unlisted company makes either a fresh issue of shares or some of its existing shareholders make an offer to sell of part of their existing shareholding for the first time to the public. This paves the way for the listing and trading of such shares. An IPO of fresh shares is typically made by a company when it needs money for growth-expansion or diversification or acquisitions or even to meet its increasing working capital requirements. In an IPO involving an offer for sale, the proceeds go to the selling shareholders.

Further Public Offering (FPO)

Is when an already listed company makes either a fresh issue of securities to the public or the existing promoters make an offer for sale to the public. An FPO, where fresh securities are issued, is typically made by a company when it needs money for growth-expansion or diversification or acquisitions or even to meet its increasing working capital requirements. An FPO is also the preferred route (over a rights issue) when the company wants to bring in new investorsboth institutional as well as retail. It may be pointed out that the FPO route is also being utilized extensively by the Government for the PSUs for the purpose of disinvestment of government’s holdings.

Regarding price of shares offered in an IPO or an FPO, SEBI does not play any role in price fixation. The issuer company decides the price. In support of this, it is required to give full disclosures in the offer document and also justify the issue price by parameters such as EPS, PE multiples and return on net worth and comparison of these parameters with peer group companies. There are two types of issues. In one, the company fixes a specified price (called fixed price issues). In the other, the company stipulates a floor price or a price band (within 20%) and invite bids from the market to then determine the final price (called book building issues). In the case of FPOs, the issue price is normally at a discount to the current market price. Some companies, and specifically PSUs, offer a discount to the retail investors in both IPOs and FPOs up to a maximum 10%.

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